Nash Equilibrium Without Mutual Knowledge Of Rationality

Abstract:     
In a Nash equilibrium, players' rationality is mutual knowledge. However, both intuition and experimental evidence suggest that players do not know for sure the rationality of opponents. This paper proposes a new equilibrium concept, cautious equilibrium, that generalizes Nash equilibrium in terms of preferences in two person strategic games. In a cautious equilibrium, players do not necessarily know the rationality of opponents, but they view rationality as infinitely more likely than irrationality. For suitable models of preference, cautious equilibrium predicts that a player might take a "cautious" strategy that is not a best response in any Nash equilibrium.

JEL Classifications: C72, D81

Accepted Paper Series