Discussion Paper, Center for Mathematical Studies in Economics and Management Science 1547
The standard framework for analyzing games with incomplete information models players as if they form beliefs about their opponents' beliefs about their opponents' beliefs and so on, that is, as if players have an infinite depth of reasoning. This strong assumption has nontrivial implications, as is well-known. This paper therefore generalizes the type spaces of Harsanyi (1967-1968) to model that players can have a finite depth of reasoning. The innovation is that players can have a coarse perception of the higher-order beliefs of other players, thus formalizing the small-world idea of Savage (1954) in a type-space context. Unlike the case in other models of finite-order reasoning, players with a finite depth of reasoning can have nontrivial higher-order beliefs about certain events. Intuitively, some higher-order events are generated by events of lower orders, making it possible for players to reason about them, even if they have a finite depth of reasoning.
bounded rationality higher-order beliefs finite depth of reasoning