The Rationality of Irrationality for Managers: Returns-Based Beliefs and the Traveler's Dilemma

34 Pages Posted: 1 Feb 2009

See all articles by Chander K. Velu

Chander K. Velu

University of Cambridge - Judge Business School

Sriya Iyer

University of Cambridge

Date Written: January 29, 2009

Abstract

This paper discusses the importance of paradoxes of irrationality for managers by elaborating upon the rational basis for the adoption of non-equilibrium strategies in game theory. It does so by revisiting the one-shot Traveler's Dilemma game, proposing a solution which reconciles the anomaly between the empirical findings and the theoretical predictions of the Nash equilibrium suggested by the game. We contend that this seeming irrationality may be based upon the subjective probabilities of the players. We proffer an alternative basis upon which beliefs in game theory might be formed - 'returns-based beliefs' - and we present the corresponding numerical results for the Traveler's Dilemma game. The importance of returns-based beliefs forming the subjective probabilities arises also because we show that they can be applied even when the players are not aware of their respective histories. We show that as long as the penalty is not too severe, then players are likely to play a high claim strategy. Our results correspond very closely to other empirical studies of the Traveler's Dilemma. Therefore, we argue that understanding the rational basis for game-theoretic paradoxes of irrationality might have important and practical uses for managerial decision-making.

Keywords: Traveler's Dilemma, Rationality, Subjective Probabilities, Returns-Based Beliefs

JEL Classification: C72, D43

Suggested Citation

Velu, Chander K. and Iyer, Sriya, The Rationality of Irrationality for Managers: Returns-Based Beliefs and the Traveler's Dilemma (January 29, 2009). Available at SSRN: https://ssrn.com/abstract=1334909 or http://dx.doi.org/10.2139/ssrn.1334909

Chander K. Velu (Contact Author)

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom

Sriya Iyer

University of Cambridge ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

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