Inclusive Cognitive Hierarchy
39 Pages Posted: 18 Feb 2020 Last revised: 17 May 2021
Date Written: January 28, 2020
Cognitive hierarchy theory, a collection of structural models of non-equilibrium thinking, in which players' best responses rely on heterogeneous beliefs on others' strategies including naive behavior, proved powerful in explaining observations from a wide range of games. We propose an inclusive cognitive hierarchy model, in which players do not rule out the possibility of facing opponents at their own thinking level. Our theoretical results show that inclusiveness is crucial for asymptotic properties of deviations from equilibrium behavior in expansive games. We show that the limiting behaviors are categorized in three distinct types: naive, Savage rational with inconsistent beliefs, and sophisticated. We test the model in a laboratory experiment of collective decision-making. The data suggests that inclusiveness is indispensable with regard to explanatory power of the models of hierarchical thinking.
Keywords: cognitive hierarchy, collective decision-making, level-k model, strategic thinking
JEL Classification: C91, C92, D72, D91
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