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Breakdowns

(by Sven Rady, with Godfrey Keller)

 

Theoretical Economics 10, 2015, pp. 175-202

An earlier version of this paper was circulated as:
Breakdowns
SFB/Transregio 15 Discussion Paper No. 396

Freely available at https://econtheory.org/ojs/index.php/te/article/viewFile/20150175/12322/376

 

Abstract
We study a continuous-time game of strategic experimentation in which the players try to assess the failure rate of some new equipment or technology. Breakdowns occur at the jump times of a Poisson process whose unknown intensity is either high or low. In marked contrast to existing models, we find that the cooperative value function does not exhibit smooth pasting at the efficient cutoff belief. This finding extends to the boundaries between continuation and stopping regions in Markov perfect equilibria. We characterize the unique symmetric equilibrium, construct a class of asymmetric equilibria, and elucidate the impact of bad versus good Poisson news on equilibrium outcomes.

Keywords: Strategic experimentation, two-armed bandit, Bayesian learning, Poisson process, piecewise deterministic process, Markov perfect equilibrium, differential-difference equation, smooth pasting, continuous pasting.
JEL classification. C73, D83, O32.

 


 

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