Fast equilibrium selection by rational players living in a changing world

Krzysztof Burdzy, David M. Frankel, Ady Pauzner

Research output: Contribution to journalArticlepeer-review

Abstract

We study a coordination game with randomly changing payoffs and small frictions in changing actions. Using only backwards induction, we find that players must coordinate on the risk-dominant equilibrium. More precisely, a continuum of fully rational players are randomly matched to play a symmetric 2 × 2 game. The payoff matrix changes according to a random walk. Players observe these payoffs and the population distribution of actions as they evolve. The game has frictions: opportunities to change strategies arrive from independent random processes, so that the players are locked into their actions for some time. As the frictions disappear, each player ignores what the others are doing and switches at her first opportunity to the risk-dominant action. History dependence emerges in some cases when frictions remain positive.

Original languageEnglish
Pages (from-to)163-189
Number of pages27
JournalEconometrica
Volume69
Issue number1
DOIs
StatePublished - Jan 2001

Keywords

  • Dynamic games
  • Equilibrium selection
  • Payoff shocks
  • Risk-dominance

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