Equilibrium selection through forward induction in cheap talk games

Abstract

This paper provides a refinement that uniquely selects the ex-ante Pareto dominant equilibrium in a cheap talk game, provided one exists. The refinement works by embedding any cheap talk game into a class of two-stage games where: in stage 1 sender and receiver can, at a cost, alter their preferences; and in stage 2 the cheap talk game is played. For such games, we show that a forward induction logic can be invoked to select the ex-ante Pareto-dominant equilibrium in the second stage. Cheap talk games with exogenously fixed preferences are then treated as limiting cases of this larger class of games.