Experimental Tests of a Sequential Equilibrium Reputation Model

We test whether a model of reputation formation in an incomplete information game, sequential equilibrium, predicts behavior of players in an experiment. Subjects play abstracted lending game: a B player lends or does not lend; then if B lends, an E can pay back or renege. The game is played 8 times, and there is a small controlled that the E player's induced preferences make him prefer to pay back (but he prefers to renege). In sequential equilibrium, even E players who prefer to should pay back in early periods of the game, and renege with increasing frequency in later periods, to establish reputations for preferring to pay back. After many repetitions of the 8-period game, actual play is roughly like the sequential equilibrium, except that E pay back later in the game and more often than they should. This behavior is if B players have a "homemade" prior probability of. 17 (in addition to the probability) that E players will prefer to pay back. We conclude that sequential with homemade incomplete information describes actual behavior well enough it is plausible to apply it to theoretical settings where individuals make choices (e. g. , markets, labor markets, bargaining).