Coordination in a Repeated Stochastic Game with Imperfect Monitoring

Abstract

We consider a repeated stochastic coordination game with imperfect public monitoring. In the game any pattern of coordinated play is a perfect Bayesian Nash equilibrium. Moreover, standard equilibrium selection argumentsneither have no bite or they select an equilibrium that is not observed in actual plays of the game. We give experimental evidence for a unique equilibrium selection and explain this very robust finding by equilibrium selection based on behavioral arguments, in particular focal point analysis,nprobability matching and over-confidence. Our results have interesting applicationsnin finance because the observed equilibrium exhibits momentum,nreversal and excess volatility. Moreover, the results may help to explain why technical analysis is a commonly observed investment style.