Limited Depth of Reasoning and Failure of Cascade Formation in the Laboratory

We examine the robustness of information cascades in laboratory experiments. Apart from the situation in which each player can obtain a signal for free (as in the experiment by Anderson and Holt (1997), American Economic Review, 87 (5), 847–862), the case of costly signals is studied where players d...

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Bibliographic Details
Published in:The Review of economic studies 2004-04, Vol.71 (2), p.425-441
Main Authors: Kubler, Dorothea, Weizsacker, Georg
Format: Article
Language:English
Subjects:
Access to information
Business studies
D83
Economic analysis
Economic theory
Error rates
Experiments
Game theory
Games
Herding
Herds
Information dissemination
Laboratories
Laboratory
Nash equilibrium
Normal form games
Observed choices
Reason
Reasoning
Scientific research
Studies
Theater
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Summary:We examine the robustness of information cascades in laboratory experiments. Apart from the situation in which each player can obtain a signal for free (as in the experiment by Anderson and Holt (1997), American Economic Review, 87 (5), 847–862), the case of costly signals is studied where players decide whether or not to obtain private information, at a small but positive cost. In the equilibrium of this game, only the first player buys a signal and makes a decision based on this information whereas all following players do not buy a signal and herd behind the first player. The experimental results show that too many signals are bought and the equilibrium prediction performs poorly. To explain these observations, the depth of the subjects' reasoning process is estimated, using a statistical error-rate model. Allowing for different error rates on different levels of reasoning, we find that the subjects' inferences become significantly more noisy on higher levels of the thought process, and that only short chains of reasoning are applied by the subjects.
ISSN:0034-6527
1467-937X
DOI:10.1111/0034-6527.00290