Prospect Theory Preferences in Noncooperative Game Theory

Abstract

The present work seeks to incorporate a popular descriptive, empirically grounded model of human preference under risk, prospect theory, into the equilibrium theory of noncooperative games. Three primary, candidate definitions are systematically identified on the basis of classical characterizations of Nash Equilibrium; in addition, three equilibrium subtypes are defined for each primary definition, in order to enable modeling of players' reference points as exogenous and fixed, slowly and myopically adaptive, highly flexible and non-myopically adaptive. Each primary equilibrium concept was analyzed both theoretically and empirically; for the theoretical analyses, prospect theory, game theory, and computational complexity theory were all summoned to analysis. In chapter 1, the reader is provided with background on each of these theoretical underpinnings of the current work, the scope of the project is described, and its conclusions briefly summarized. In chapters 2 and 3, each of the three equilibrium concepts is analyzed theoretically, with emphasis placed on issues of classical interest (e.g. existence, dominance, rationalizability) and computational complexity (i.e, assessing how difficult each concept is to apply in algorithmic practice, with particular focus on comparison to classical Nash Equilibrium). This theoretical analysis leads us to discard the first of our three equilibrium concepts as unacceptable. In chapter 4, our remaining two equilibrium concepts are compared empirically, using average-level data originally aggregated from a number of studies by Camerer and Selten and Chmura; the results suggest that PT preferences may improve on the descriptive validity of NE, and pose some interesting questions about the nature of the PT weighting function (2003, Ch. 3). Chapter 5 concludes, systematically summarizes theoretical and empirical differences and similarities between the three equilibrium concepts, and offers some thoughts on future work.

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