Recursive Lexicographical Search: Finding All Markov Perfect Equilibria of Finite State Directional Dynamic Games

62 Pages Posted: 3 Jul 2014

See all articles by Fedor Iskhakov

Fedor Iskhakov

University of New South Wales (UNSW) - ARC Centre of Excellence in Population Ageing Research (CEPAR)

John Rust

Department of Economics, Georgetown University

Bertel Schjerning

University of Copenhagen - Department of Economics

Date Written: June 2, 2014

Abstract

We define a class of dynamic Markovian games that we call directional dynamic games (DDG) in which directionality is represented by a partial order on the state space. We propose a fast and robust state recursion algorithm that can find a Markov perfect equilibrium (MPE) via backward induction on the state space of the game. When there are multiple equilibria, this algorithm relies on an equilibrium selection rule (ESR) to pick a particular MPE.We propose a recursive lexicographic search (RLS) algorithm that systematically and efficiently cycles through all feasible ESRs and prove that the RLS algorithm finds all MPE of the overall game. We apply the algorithms to find all MPE of a dynamic duopoly model of Bertrand price competition and cost reducing investments which we show is a DDG. Even with coarse discretization of the state space we find hundreds of millions of MPE in this game.

Keywords: Dynamic games, directional dynamic games, Markov-perfect equilibrium, subgame perfect equilibrium, multiple equilibria, partial orders, directed acyclic graphs, d-subgames, generalized stage games, state recursion, recursive lexicographic search algorithm, variable-base arithmetic,successor function

JEL Classification: D92, L11, L13

Suggested Citation

Iskhakov, Fedor and Rust, John and Schjerning, Bertel, Recursive Lexicographical Search: Finding All Markov Perfect Equilibria of Finite State Directional Dynamic Games (June 2, 2014). Available at SSRN: https://ssrn.com/abstract=2461644

Fedor Iskhakov

University of New South Wales (UNSW) - ARC Centre of Excellence in Population Ageing Research (CEPAR) ( email )

Level 6 Central Lobby (enter via East Lobby)
Australian School of Business Building
Sydney, New South Wales NSW 2052
Australia

John Rust

Department of Economics, Georgetown University ( email )

Washington, DC 20057
United States
1-202-687-6806 (Phone)
1-202-687-6102 (Fax)

Bertel Schjerning (Contact Author)

University of Copenhagen - Department of Economics ( email )

Ă˜ster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
Denmark

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