Hindsight, Foresight, and Insight: An Experimental Study of a Small-Market Investment Game with Common and Private Values

Abstract

We experimentally test an endogenous-timing investment model in which subjects observe their cost of investing and a signal correlated with the common investment return. Subjects overinvest, relative to the Nash benchmark.We can separately consider whether a subject draws inferences from the other subject's investment, in hindsight, and whether a subject has the foresight to delay profitable investment and learn from market activity. In contrast to Nash, cursed equilibrium, and level-k belief predictions, behavior remains the same across our experimental treatments. Our maximum likelihood estimates are inconsistent with belief-based theories, but are consistent with the notion that subjects use simple rules of thumb, based on insights about the game.

On the persistence of strategic sophistication

“…Many papers find strong support for Level-k play in certain games using behavioral data alone [62,63,54,31,42,10,18] or behavioral data augmented with lookup data [24,23] or eye-tracking data [19,65]. For some games, however, the Level-k model does not appear to organize the data well [43,44,26]. 38 [60] even find that the model's fit can vary within a single game when different components of the payoff function are emphasized, with a better fit as the game becomes closer to a standard p-beauty contest and a worse fit as the game approaches the incomplete-information global game of [52].…”

“…For example, [43] identify plausible "rules of thumb" to explain their data when Level-k and quantal 38 [26] point out that the Level-k model fails to account for overbidding in second-price auctions.…”

Herding, contrarianism and delay in financial market trading

“…Finally, since we already have noise traders built into the experiment, by opting to allow traders to increase their estimates of the percentage of expected noise trades above 25% our method is arguably an especially simple and intuitive rule of thumb which enables subjects to incorporate naive reasoning on the part of their peers. For more on rules of thumb by laboratory subjects in a herding context see Ivanov, Levin and Peck (2008).…”

“…They do not employ information that could (theoretically) trigger herding or contrarianism. Ivanov, Levin, and Peck (2009) implement Levin and Peck (2008), which is a model of fixed capital (green-field), non-financial investments, and they develop important insights into the timing behaviour of people's investment choices. Their setting does not, however, consider moving prices.…”

Cognitive Sophistication and Deliberation Times

“…For example, Ivanov et al (2009) show that level-k ceases to describe behavior well when the best-reply structure is complex and alternative plausible rules of thumb exist. Chong et al (2016) show that incorporating a measure of saliency to derive level-0 behavior significantly improves model fit with respect to models where non-strategic agents randomize uniformly.…”