Additional exercises on Perfect Bayesian Equilibrium

LAM, Wing Tung

YSS 3208 Fall 2019

Private information in dynamic setting

• We are going to study how information asymmetry affects strategic interactions in
an extensive form game. We will study the following new considerations

– Suppose a player, say player 1, has received her private information and is about
to make a move. Holding other players’ belief about player 1’s type constant,
player 1, in general, acts on her private information and chooses her action
accordingly.
– The other players will then infer player 1’s private information from her choice
of action. They will revise their belief about the player 1’s type based on her
action.
– This in turn affects the player 1’s incentive at the first place. She anticipates
how her choice of action affects the others’ belief about her own private type,
and hence their future actions. Accounting for such effects, she may pick a
different action.
– The other players will then factor in the player 1’s incentives when they infer
her private type.

• The above considerations are at the heart of the “signaling” models and “reputational
concerns” models.

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 Sequential Rationality

• Recall that in extensive-form games, we require the player’s action at a node, be it

on or off the equilibrium path, to be a “best response” to other players’ strategies.

– The reason is that as the events unfold, the players can always adjust the course
of action as they see fit.
– However, to put the concept into work, the difficulty lies in the calculation of
expected payoffs in the presence of imperfect or incomplete information.

• We introduced the notion of the subgame perfect equilibrium earlier. However, games
with incomplete information, or private types, tend to have few or even no proper
subgames. SPE loses much of its bite in such cases.

• We are going to introduce another refinement over Nash equilibrium, which makes
the set of equilibria weakly smaller in extensive form games.

• We first introduce a new concept: system of beliefs

• Consider a non-degenerate information set, which contains two or more nodes. The
player’s belief about what has happened can be represented by a probability distri-
bution over the nodes in the information set.

• We can specify a belief over the nodes for every information set. The collection of
such beliefs is termed as a system of beliefs.

• In the subsequent discussion, we assume that the system of belief and the strategy
profile are common knowledge among the players.

– Different equilibrium definition imposes different JOINT restrictions on the sys-

tem of belief and the strategy belief. We will return to the joint restrictions
shortly

• Suppose we have the system of belief and the strategy profile both in hand. For each
of the information sets, we will know the following:

– We find out the path of play from the strategy profile. We can determine whether
the information set is on or off the path of play.

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 – For each node in the information set, the strategy profile specifies the players’
future actions following each possible action
– Together with the belief at that node, we can the find out the player’s continu-
ation payoff for every possible action at that information set.
– We can then work out the (set of) player’s optimal action at the information
set!

• A system of belief and a strategy profile satisfies the sequential rationality if for every
information set, the strategy profile specifies an action which maximizes the player’s
continuation payoff.

Exercise. Sequential rationality has bites even in the games of imperfect infor-
mation (without private types).

Source: A Course in Game Theory

1. Show that (L, L) and (R, R) are both N.E. Notice that in the normal form
game representation the player 2’s pure strategy R weakly, but not strictly,
dominates L.
2. Find out the set of SPE for this game
3. Let us represent player 2’s belief using (q, 1 − q). Argue that not matter
what value q takes, only the strategy profile (R, R) can satisfy sequential
rationality

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Consistency of belief
• Consider an information set ON the path of play, the strategy profile would specify all
the previous actions leading to that information set. We assume that whenever this
information set is reached, the player believes that no players have deviated before.
This assumption is embodies in the requirement that the belief at the information
set must be derived from the strategy profile using Baye’s law.

• For a a strategy profile, we say that a system of belief is consistent on-the-path with
if for every information set on the path of play, the belief is derived from the strategy
profile using Baye’s law.

Example (continued). Recall that player 2’s belief using (q, 1 − q)

Source: A Course in Game Theory

The following pairs of strategy profile and system of belief satisfy the consistency
requirement on the path of play.

1. (L, R) and q = 1. Sequential rationality and consistency of belief are distinct

requirements. Furthermore, player 2 needs not believe that player 1 chooses
the most profitable deviation.
2. (R, L) and q = 0.
3. (L, L) and q = 0.4. Notice that we impose no restrictions on the belief off
the path of play.

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 Exercise (continued). Suppose player 1 uses the mixed strategy
(σ1 (L), σ1 (M ), σ1 (R)) = (0.4, 0.4, 0.2). What value of q is consistent with
player 1 strategy on-the-path?

Perfect Bayesian Equilibrium

• A Perfect Bayesian equilibrium (PBE) consists of a strategy profile and a system of
belief which satisfies both sequential rationality and belief consistency on-the-path

Exercise. The following game features incomplete and imperfect information.

Player 2 does not observe player 1’s type and her past action when making a
move.

Source: Strategy, An Introduction to Game Theory

For each of the following pairs of strategy profile and belief, explain whether it
is a PBE.

1. (AC, F ) and p = 1, q = 0
2. (AD, G) and p = q = 0
3. (BD, F ) and p = 0.5, q = 0

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 Exercise. The following game features incomplete information. Player 2 does not
observe player 1’s private type when deciding her action.

Source: Strategy, An Introduction to Game Theory

1. Find out all pure strategy PBE where player 2 plays U , if any
2. Find out all pure strategy PBE where player 2 plays D, if any

Notice that in a PBE, if q 6= 0.5, then player 2 revises her belief about player 1’s
private type based on the latter’s choice of action. Both players account for the
revision in belief when deciding their actions.

– Sequential rationality may impose restriction on the belief of an off-the-path

information set.

• To facilitate the comparison with other equilibrium definitions, we say that a strategy
profile is supported in a PBE if we can find a system of belief so that the two
constitutes a PBE.

Remark. A strategy profile supported in a PBE is also an NE.

– For a NE, we can derive the beliefs for the information sets on the path of play
using Baye’s law.

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 – It can be shown that the players are sequential rational on the path of play. That
is, for every information set on the path of play, the player’s action maximizes
her continuation payoff.
– For off-the-path information sets, a NE may specify an action which is never
optimal. This is the main difference between PBE and NE.

• The preceding discussion suggests a procedure to calculate the set of PBE in a general
game.

1. Find out the set of NE.

2. For each of the NE, construct a belief of system in the following manner
– For every information set on the path of play, we derive the belief from the
strategy profile using Baye’s law.
– For every information set off the path of play, we find a belief for which
the chosen action will be optimal. If we can construct one such belief for
every off-the-path information set, then sequential rationality is met and
we obtain a PBE. Otherwise, the strategy profile cannot be supported in a
PBE.

Exercise. Bill is a politician and a sexual predator in closet. He committed crimes

in secrecy and in various places so that his victims do not know of each other. A
victim may report to the police right after the sexual assault and the accusation
will be made public. Any report made long after the sexual assault has occurred
will be discredited as politically motivated. Bill has a team of good defence
lawyer who will save him in the court. But multiple accusations will terminate
his political career.

However, a victim knows neither how many times Bill had committed similar
crimes before nor whether Bill will commit similar crimes in the future. To
capture this uncertainty, we suppose there are two periods t = 1, 2 and two
victims i = 1, 2. The victims “arrive” in random sequence.

Case A: victim 1 arrives in period 1 and victim 2 arrives period 2. Victim 1 may
decide whether to report (R) and keep silent (S) in period 1. If she keeps silent

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in period 1, she cannot make the accusation in period 2 as it will be discredited.
Victim 2 may decide whether to report and keep silent in period 2. Before making
her decision, Victim 2 would observe victim 1’s report, if the latter reports in
period 1.

Case B: victim 2 arrives in period 1 and victim 1 arrives period 2. Case A and
B are symmetric and only the roles of two victims are interchanged.

Both cases occur with one-half probability. The problem is that the victims
themselves do not know which of the two cases has occurred. The only exception
is that the victim in the first period, say victim 1 in case A, makes a report
in period 1. Then the next victim, say victim 2, would know that she arrives
in period 2. If the victim 1 remains silent in case A, then victim 2 cannot tell
whether she arrives in period 2 in case A or period 1 in case B when she makes
her decision.

Reporting costs the victim -1 as it reveals the sexual assault to the others. Bill’s
political career comes to an end only if both victims accuse him. In that case,
the victims receive a payoff of 2, or 1 after deducting the cost. If no reports or
only one reports, the victims receive a payoff of 0. Nevertheless, the reporting
victim still occurs a cost of -1.

1. Draw the game tree and define the pure strategy of a victim

Hint: Think carefully about what the information sets of a victim are
2. Work out the set of pure strategy PBE.

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 Comparison with subgame perfection

Remark. In games with perfect information, the sets of SPE and PBE are the
same

– The concept of sequential rationality is equivalent to backward induction in the

games with perfect information.

• In general games, a SPE needs not be supported in a PBE. A strategy profile sup-
ported in a PBE needs not be a SPE.

Exercise. In the following game, the player 1’s pure strategy SR does not weakly
dominates the SL.

Source: A Course in Game Theory

Find out and compare the sets of SPE and PBE. Do you find the player 2’s belief
in the two PBE “credible”?

– In some games, PBE can be less effective in ruling non-credible belieft than
SPE.

• Sequential equilibrium is a refinement over both SPE and PBE. However, its calcu-
lation is far more involved and beyond the scope of the module.