Graduate micro II Patrick Legros

Example of sequential equilibrium

Consider the following game
1

1
2

3 a b

1,1,1

1
3,2,2

0,0,1

1
4,4,0

0,0,0

Each player has two actions (left and right). Typical behavioral strategies are represented in the gure; for instance is the probability with which player 1 plays L, etc. There are many Nash equilibria; in particular (, , ) = (1, 0, 0) and (, , ) = (0, 0, 1) are Nash equilibria. (1, 0, 0) is Nash because player 2 plays R with probability one - even if player 2s action does not aect his payo since player 1 plays L with probability one; however if player 2 plays L, then player 1 would prefer to play R rather than L in order to get 4 instead of 3. Consider a vector of strategies (, , ) . This vector is part of a sequential equilibrium if we can nd a belief structure at the information set of player 3, that is a probability p (a) assigned to node a such that (i) one can nd a sequence {(k , k , k )} k=1 converging to (, , ) , and a probability p (b) such that k (i) p (b) = limk k k (1k ) (ii) (, , ) is sequentially rational. We describe below the set of sequential equilibria. First, consider sequential rationality. Player 1 compares the expected utility 3 (1 ) of playing L to the expected utility 1 + 4 (1 ) of playing R, since 3 (1 ) 1 + 4 (1 ) is 1

equivalent to 2 3 (3 4 ) , the best response correspondence for player 1 is =0 < =1 as 2 3 > (3 4 ) (SR1) [0, 1] = Similar computations show that the best response for player 2 is =0 > =1 as < [0, 1] =

3 4

(SR2)

and for player 3 is =0 > =1 as p (a) < [0, 1] =

1 3.

(SR3)

Case 1: = 0. Then, (SR2) implies that 3 4 , and (SR3) implies that 3 p (a) 1 . Since = 0 and , 2 3 < (3 4 ) and (SR1) implies 3 4 that = 0. Now, since = = 0, the information set of player 3 is not 3 reached. The belief p (a) 1 3 that makes 4 sequentially rational for player 3 must therefore be obtained as the limit of posteriors obtained from a sequence {(k , k , k )} k=1 converging to (, , ) = (0, 0, ) . For 1 k each element of the sequence, pk (a) = k + (1 k ) ; for instance, if k = k2 k 1 1 1 and k = k , pk (a) = k2 0 < 3 . Remark 1 It is straigthforward that any p (a) can be made fully consistent. Case 2: > 0. Then, (SR2) implies that 3 4 and (SR3) implies in turn 3 . By (SR3), requires p ( a ) 1 that p (a) 1 3 4 3 .Since > 0, player 3s information set is reached with positive probability and beliefs are com 1 puted by Bayes law, p (a) = +(1 ) and thererore we need + (1) 3 , or . 2+ This inequality is impossible however. Since > 0, (SR1) requires that 2 3 (3 4 ) .
2+

> 0, and (*)

1 4

if (0, 1) , then (SR2) requires = 3 4 , but then (*) becomes which is absurd

if = 1, then (*) is equivalent to 1, which contradicts 3 4.

Therefore the set of sequential equilibria is the set 3 1 ((0, 0, ) , p (a)) : , 1 , p (a) 0, . 4 3 In particular, Nash equilibria in which player 1 plays L cannot be sequential. Remark 2 A sequential equilibrium must specify the strategy vector and the belief structure.