Rationalizing Irrational Beliefs

Abstract

In this paper we propose a “behavioral equilibrium” definition for a class of dynamic games of perfect information. We document various experimental studies of the Centipede Game in the literature that demonstrate that players rarely follow the subgame perfect equilibrium strategies. Although some theoretical modifications have been proposed to explain the outcomes of the experiments, we offer another: players can choose whether or not to believe that their opponents use subgame perfect equilibrium strategies. We define a “behavioral equilibrium” for this game; using this equilibrium concept, we can reproduce the outcomes of those experiments.