Abstract
In this paper, we study a 2 × 2 Bayesian entry game with correlated private information. The distribution of private information is modelled by a symmetric joint normal distribution. Therefore, the correlation coefficient of the private information distribution reflects the degree of dependence of players' private information. Under such specification, players' private information can be correlated flexibly, which is not confined to the typical additive specification of private payoff shocks or private information by Carlson and van Damme (1993), where the private information is correlated due to the common payoff shock. In our game, if the private information is correlated, we find that given the variances of the private information, there exists a restriction on the degree of correlation of players' private information that allows the game can be solved by cutoff strategies. Specifically, given the variances of the private information, if players' private information in strategic substitutes (strategic complements) Bayesian games are positively (negatively) correlated, the range of correlation coefficient that allows the game can be solved by cutoff strategies is restricted so that if the correlation is out of the range, the game cannot be solved by cutoff strategies. Alternatively, given positive (negative) correlation of private information, the value of variances that allows a strategic substitutes (strategic complements) Bayesian games can be solved by cutoff strategies are restricted within certain range. If the value of variances fall out of the range, the Bayesian game cannot be solved by cutoff strategies. However, given negative (positive) correlation of players' private information in strategic substitutes (strategic complements) Bayesian games, in which the Bayesian games can always be solved by cutoff strategies, we prove that as the variances converge to zero, all pure strategy Bayesian Nash equilibria of the perturbed games converge to the respective Nash equilibria of the corresponding strategic substitutes (strategic complements) complete information games. Based on the result, we conclude that the purification rationale proposed by Harsanyi (1973) can be extended to games with dependent perturbation errors that follow a symmetric joint normal distribution if the correlation coefficient is positive for the strategic complements games or negative for the strategic substitutes games.
Highlights
This paper develops a simple model of firm entry with correlated private information in a 2-player static game
For the strategic complements complete information games if the perturbation errors are negatively correlated, or for the strategic substitutes complete information games if the perturbation errors are positively correlated, there does not exist a Bayesian game that can be solved by the cutoff strategy as perturbation errors tend to zero
We find that in these situations, the Bayesian games that are supposed to converge to the complete information game as the perturbation errors degenerate to zero exist, and during the process, the pure-strategy Bayesian Nash equilibrium will converge to the corresponding Nash equilibrium of the underlying complete information game
Summary
This paper develops a simple model of firm entry with correlated private information in a 2-player static game. The intuition is that if the correlation coefficient is smaller (greater) than this critical value for a strategic complements (strategic substitutes) game, the expected payoff function is no longer monotonic with respect to the player’s own strategies, which contradicts the definition of either strategic complements games or strategic substitutes games In such a situation, cutoff strategies cannot be used to solve the game. The intuition is that by assuming the variances of both players’ type distributions are identical, for negative information correlation in the strategic complements game or the positive correlation in the strategic substitutes game, there exists a critical value of variances, below which the expected payoff function is not monotonic with respect to a player’s own private payoff shock.
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