DP16644 Cognitive Imprecision and Strategic Behavior
We propose and experimentally test a theory of strategic behavior in which players are cognitively imprecise and perceive game payoffs with noise. We focus on 2 x 2 coordination games that have multiple equilibria when perception is precise. Introducing cognitive imprecision generates a unique equilibrium. The model further predicts stochastic and context-dependent behavior: as volatility in the environment increases, perception becomes noisier and actions become less sensitive to payoffs. Context-dependence arises from an efficient use of limited cognitive resources. Our experimental data strongly support these predictions and reject a broad class of theories that do not predict context-dependence. In a second experiment, we shut down strategic uncertainty by incentivizing subjects to play the same coordination game against an algorithmic opponent. A decomposition analysis reveals that errors in encoding and processing payoffs are responsible for approximately half of the noise observed in games with human opponents.
