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Experimental Tests of a Sequential Equilibrium Reputation Model

Colin Camerer
Keith Weigelt

Abstract

We test whether a model of reputation formation in an incomplete information game, using sequential equilibrium, predicts behavior of players in an experiment. Subjects play an abstracted lending game: a B player lends or does not lend; then if B lends, and E player can pay back or renege. The game is played 8 times, and there is a small controlled probability that the E player's induced preferences make him prefer to pay back (but usually he prefers to renege). In sequential equilibrium, even E players who prefer to renege should pay back in early periods of the game, and renege with increasing frequency in later periods, to establish reputations for preferring to pay back. After many repetitions of the 8-period game, actual play is roughly like the sequential equilibrium, except that E players pay back later in the game and more often than they should. This behavior is rational if B players have a "homemade" prior probability of .17 (in addition to the controlled probability) that E players will prefer to pay back. We conclude that sequential equilibrium with homemade incomplete information describes actual behavior well enough that it is plausible to apply it to theoretical settings where individuals make choices (e.g., product markets, labor markets, bargaining).