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David A. Malueg

October 23, 2006

Abstract

An innite-horizon perfect-information centipede game is studied. The unique subgame-perfect

Nash equilibrium (SPNE) in pure strategies has each player choose, at each opportunity, to terminate

the game. In contrast, mixed strategies can yield equilibrium cooperation described as follows: for

all but nitely many periods players randomize between terminating and continuing the game. These

continuation probabilities are explicitly calculated. If both players payo functions are unbounded, then

there exist SPNE exhibiting such cooperation. Conditions are also derived under which such cooperation

does not arise.

Keywords: centipede game, cooperation

While retaining responsibility for any errors, the author thanks Stefano Barbieri and Christopher Snyder for their comments

on an earlier draft of this paper.

Department of Economics, Tulane University, 206 Tilton Hall, New Orleans, LA 70118, email: dmalueg@tulane.edu.

2

R

D

Player 1: 0

Player 2: 0

1

R

1

3

2

R

2

2

1

R

1

5

R

D

R

D

4

4

3

7

2

R

6

6

1

R

5

9

2

R

8

8

10

10

7

11

Introduction

This note explores the scope for cooperation in an innite-horizon centipede game. Figure 1 depicts Rosenthals original (nite-horizon) centipede game (Rosenthal, 1981). The number at each vertex denotes the

player who has a move at that vertex. At each move, a player has a choice of D or R. If R is chosen,

the game continues to the next vertex, where the other player has a move, choosing either D or R. If D

is chosen, the game stops and payos at the terminal node are realized. At each terminal node, the upper

number is the payo to player 1 and the lower number is the payo to player 2. By the familiar logic of

backward induction, there is only one subgame perfect Nash equilibrium (SPNE): if players reach the last

decision node, player 2 will choose D, earning a payo 11 rather than 10; recognizing this, at the penultimate

decision node player 1 would choose D to obtain a payo of 8 rather than choosing R and receiving a payo

of 7 when player 2 terminates the game. The logic rolls back to the beginning of the game, implying that

each player chooses D whenever he has a move. This is not a desirable outcome for the playersterminal

nodes at all stages beyond the second Pareto dominate the SPNE outcome. Players would do better if only

they were more cooperative. But what would justify such cooperation?

Neyman (1985) shows that if the strategies players can use are limited in their complexity, then cooperation can arise in the nitely-repeated prisoners dilemma, for example. However, in a game very similar to

the centipede game, Megiddo (1986) argues that limits on complexity do not there yield cooperation because

the strategies inherently are already very simple. Without such limitations on players reasoning or computational abilities, Aumann (1995, 1996, 1998) shows such cooperation among rational players is impossible

if players rationality is itself common knowledge. Another explanation for a degree of cooperative behavior,

which many observers intuitively expect to see in the centipede game, adds a possibility that one or both

players are irrational, an approach pioneered by Kreps et al. (1982). For example, the approaches of

Binmore (1987, 1996), Kreps (1990), and McKelvey and Palfrey (1992) would have rational/selsh players

with payos as given in Figure 1. These authors then add the possibility that a player may be an altruist,

for whom choosing R is always optimal. In such a situation, [i]f it is believed that there is some likelihood

that each player may be an altruist, then it can pay a selsh player to try to mimic the behavior of an

altruist in an attempt to develop a reputation for passing [choosing R] (McKelvey and Palfrey, p. 805).

Such a model explains many of the features McKelvey and Palfrey nd in their experiments.

The introduction of an innite horizon often admits possibilities for cooperation not found in nitehorizon models. For example, consider a one-period Cournot duopoly in which there is a unique Nash

equilibrium with both rms producing positive outputs. To earn higher prot, rms would like to collude; but

even if this static game is repeated any xed nite number of times, collusion cannot arise in a SPNE (Radner,

1980). However, if the rms interaction is repeated indenitely, then grim trigger strategies can support as

a SPNE an outcome in every period that is more protable than the static Cournot duopoly equilibrium.

The grim trigger strategy imposes as punishment eternal reversion to the static Cournot equilibrium if either

player deviates from its component of the more protable outcome they seek to implement. If players do not

discount the future payos too heavily, then the loss of high future payos following cheating outweighs the

short-term gain from cheatingcooperation is sustained with the big stick of eternal punishment (see, for

example, Friedman, 1990). Beyond grim trigger strategies, Abreu (1986, 1988) showed that stick-and-carrot

strategies can sustain cooperative outcomes even better than can a grim trigger strategy. In contrast to

these collusive oligopolies, in the innite-horizon centipede game such trigger punishments are not available

because once a player terminates the game, there are no future periods! Instead, cooperation arises when

the prospects for a larger future payo are suciently attractive that a player does not prefer to end the

game in the current period.1

More closely related to the nding of cooperation in the centipede game is the literature on gradualism

and dynamic contribution to a public good. The ineciency of private provision of public goods is well-known

in settings where players have only one opportunity to contribute (e.g., Bliss and Nalebu, 1984; Cornes and

Sandler, 1996; Palfrey and Rosenthal, 1984; Varian, 1994). Shelling (1960) suggested that ineciencies in

an agreement subject to opportunism, however, might be mitigated if the agreement is divided into small

pieces so that at each step relatively little is at risk.

Admati and Perry (1991) explore just such a mechanism, with players taking turns contributing to

the funding of a public good, and nd that indeed ineciency can be partially alleviated. Lockwood and

Thomas (2002) and Marx and Matthews (2000) suppose that the contributors make their contributions

simultaneously. They too show that, compared with a one-shot game, if players divide their contributions

1 Similarly, in the public good context discussed next, Lockwood and Thomas (2002) note that in such games deviators can

only be credibly punished by the withdrawal of carrots (emphasis added).

into (possibly innitely) many small contributions that are to be made over a series of periods, then much

of the ineciency of the one-shot game can be eliminated. Pitchford and Snyder (2004) consider a buyer

and seller in a situation requiring the seller to make an investment before being paid by the buyer, and an

enforceable contract is not possible. In a single-transaction setting, the buyer will refuse to compensate the

seller, and foreseeing this the seller is unwilling to make any investment even though it is ecient to do so.

Pitchford and Snyder show that by dividing the single transaction into an innite series of smaller ones the

agents can reduce the ineciency due to the hold-up problem. Their scheme leaves at each date a suciently

large fraction of the original transaction that neither player is tempted to behave opportunistically.

Returning to the centipede game, an equilibrium is said to exhibit cooperation if there is a positive

probability that play does not terminate in the rst stage. Even in the innite-horizon game, the only

SPNE in pure strategies has play end in the rst stage. Therefore, equilibrium cooperation in the centipede

game necessarily involves mixed strategies. Focussing on equilibria in which players expected payos are

nite, I show cooperation takes the following form. There is some date, say t0 , before which players choose

continuation with probability one. At date t0 the player with the move chooses continuation with probability

at least as great as a specied threshold, and at all later dates continuation is chosen according to exactly

determined probabilities.

These continuation probabilities are determined by the usual condition that a player should be indifferent between stopping the game and continuing; and the expected payo from continuing should equal the

payo from continuing given that he will stop at the next opportunity (if the other player does not stop at the

next decision node). It turns out that the probabilities determined by the condition of indierence between

stopping at date t versus continuing, with the plan to stop at t + 2, do not always constitute an equilibrium.

The reason for this is that these probabilities can imply a positive probability that a player never chooses to

terminatewhich in turn leads to nontermination of the game or termination by the other player. Either of

these possibilities can be worse than immediate termination by a player. Thus, the exact nature of players

continuation probabilitieswhich are determined from players payosis critical to determining whether

mixed strategies can be part of a SPNE. It is shown that for equilibrium cooperation to arise, it is sucient

that both players payos be unbounded above. Conditions are also derived under which such cooperation

does not arise.

The remainder of this paper is organized as follows. Section 2 formulates an innite-horizon centipede

game. This formulation is quite exible and might be viewed as an example of a more general family

of two-player stopping games, where in each period a players only decision is whether to stop the game.

When the game terminates players payos are realized. The war of attrition is another well-known twoplayer stopping game (cf. footnote 3). Section 3 characterizes SPNE, and Section 4 concludes with several

examples, including an extension of Rosenthals game and a game of alternating contributions to fund a

public good.

The following describes an innite-horizon centipede game. There are two players, player 1 and player 2.

Players decision nodes are indexed by t, where t T {1, 2, 3, . . . }. The game begins at the node t = 1,

with play moving from node t to t + 1. Player 1 moves at the odd-numbered dates, T1 {1, 3, 5, . . . },

and player 2 moves at the even-numbered dates, T2 {2, 4, 6, . . . }. At each decision node a players set of

possible actions is A {D, R}. As in Rosenthals model, the game terminates at the rst date at which

a player chooses D. If the game terminates at t, then the realized (von Neumann-Morgenstern) payo to

player i is ui (t), i = 1, 2. If the game does not terminate, payos to both players are zero.2 To preserve the

character of Rosenthals game, I maintain the following assumption throughout.

Assumption 1.

1. 0 ui (t) < ui (t + 2) t Ti , i = 1, 2.

2. ui (t) > ui (t + 1) t Ti , i = 1, 2.

3. B > such that ui (t) B t T, i = 1, 2.

The rst condition says that in choosing between two dates at which a player might terminate the game, the

player prefers the later date. The second condition says, though, that he prefers terminating in the current

period to having the other player terminate the game in the next period. The third condition limits the

harm a player suers when the other player terminates the game. (This third condition is automatically

satised in nite-horizon centipede games.) Special cases of the centipede game are discussed in Section 4.3

2 Instead of assuming that payos to nontermination are zero, one could take the following approach. Let u0 denote the

i

payo to player i if the game does not terminate, i = 1, 2. At the cost of additional complexity, the character of the results

derived below carries over to the case where it is assumed that u0i < suptTi ui (t), i = 1, 2.

3 An alternating-decision war of attrition could also be described in a manner very similar to that describing the innitehorizon centipede game. To do this, let Ti denote the dates at which player i might choose to terminate the game by exiting,

and suppose (i) ui (t) > ui (t + 2) and ui (t) < ui (t + 1) t Ti and (ii) ui (t) > ui (t + 2) t

/ Ti . Here condition (i) says that

if player i is to give up rst, then he prefers to do so earlier rather than later; but if player i can be sure the other player would

exit in the next period, then player i will choose to stay in the contest. Condition (ii) says that if he is sure to win, player i

prefers winning sooner rather than later. The methods of analysis applied below for the centipede game could be adapted to

this alternating-decision war of attrition.

This is a game of perfect information. A pure strategy for a player simply species at each of the players

decision nodes whether to choose D or R; thus, the pure strategies for player i can be identied with the

set of functions from Ti to A. Because this is a game of perfect recall, player is set of mixed strategies is

equivalent to his set of behavioral strategies, where a behavioral strategy species at each of the players

decision nodes a probability distribution over A. Because A contains only two elements, it suces to specify

at each decision node the probability that R is chosen. Thus, player is set of mixed strategies is identied

as i {i | i : Ti [0, 1]}, with the interpretation that if called on to move at date t Ti , then player i

selects R with probability i (t).

To dene expected payos, it is convenient to introduce the player function P : T {1, 2} dened by

P (t) = i if t Ti , where i = 1, 2. The player function simply identies at each date the player who is to

move. Given strategies (1 , 2 ) 1 2 , the (expected) payo to player i in the subgame starting at date

t is dened as follows:4

Ui (1 , 2 , t) lim inf

N

N

s=t

s1

P (j) (j),

i = 1, 2.

(1)

j=t

This formulation of payos is fairly general and, with suitable interpretation of u1 and u2 , allows for consideration of discounting and exogenous probabilities of termination.

Equilibria

The analysis focusses on subgame perfect equilibria, for which the following denition is standard.

Denition 1. (1 , 2 ) 1 2 is a subgame perfect Nash equilibrium (SPNE) if

U1 (1 , 2 , t) U1 (1 , 2 , t) t T1 , 1 1 ,

and

U2 (1 , 2 , t) U2 (1 , 2 , t) t T2 , 2 2 .

In the nite-horizon centipede game, the unique SPNE has, at every decision node, the player with the move

choose D with probability one. One might wonder whether the same is true in the innite-horizon game.

Indeed it isif one considers only equilibria in pure strategies.

As in the nite-horizon centipede game, the innite-horizon game centipede game has a SPNE in which

each player chooses D at each of his decision nodes. I will call this the trivial SPNE. That this is the unique

(1) it is understood that for any t T , t1

j=t P (j) (j) = 1. In (1) the lim inf is used rather than the limit, because the

limit might not exist, owing to the possibility that payos are unbounded. It turns out that all results derived for regular

equilibria derived below also would go through if (1) used the more optimistic lim sup.

4 In

SPNE in pure strategies can be understood as follows. Let (1 , 2 ) be any SPNE in pure strategies. Then

for any t T it must be that there exists t t such that P (t ) (t ) = 0, for otherwise the game would

not terminateand either player could increase his payo (above 0) by choosing termination at any date

after t + 1. Dene t0 (t) min{ t t | P (t ) (t ) = 0 }. If t0 (t) > t, then Assumption 1 and subgame

perfection imply that at date t0 (t) 1 player P (t0 (t) 1) would terminate the project for sure; that is,

P (t0 (t)1) (t0 (t) 1) = 0. But if t0 (t) > t, then t0 (t) 1 t and P (t0 (t)1) (t0 (t) 1) = 0, contradicting the

denition of t0 (t). Consequently, t0 (t) = t, so P (t) (t) = 0; and because t T was arbitrary, it follows that

P (t) (t) = 0 for all t T . The foregoing argument establishes the following.

Theorem 1. There exists a unique SPNE in pure strategies. It has each player choose D at each of his

decision nodes.

The question motivating this paper is whether in the innite-horizon centipede game players can do

better than to play the trivial SPNE. I will say that a SPNE (1 , 2 ) exhibits cooperation if 1 (1) > 0; such

equilibria allow some chance that players realized payos will exceed those in the trivial equilibrium.

Assumption 1 allows u1 and u2 to increase without bound. Consequently, players expected payos are

not necessarily nite. While equilibria with innite expected payos are not the focus of this paper, the

following example shows such equilibria are possible.

Example 1 (SPNE with innite expected payos).

Suppose u1 and u2 exhibit increments on T1 and T2 , respectively, that are bounded below by some

> 0. Let (pt )tT be any probability distribution over T such that tTi t pt = , i = 1, 2.5 Next dene

the sequence, (

t )tT as follows:

1 1 p1

and

1

1

t

j=1

pj

j=1

pj

t1

t > 1.

t for all t Ti , i = 1, 2. It is easily checked that if players

use these strategies, then the centipede game terminates in period t with probability pt . Furthermore,

U1 (1 , 2 , t) = and U2 (1 , 2 , t) = for any t T .6 Strategies (1 , 2 ) constitute a SPNE because, at

example, (pt )tT dened by pt = 26t2 is such a sequence.

ui (t + 2) ui (t) t Ti , it follows that u1 (t) t1

t T1 and u2 (t)

2

be given and consider the subgame starting at t0 . Then, for player 1,

t1

U1 (1 , 2 , t0 ) B +

pt

2

tT ,

5 For

6 Because

tt0

t2

t T2 . Now let t0 T

any date, the player who is to move has no strategy that will yield him a greater payo.7

In this paper I focus on SPNE in which each players equilibrium payo is nite in every subgame.

Compared with the possibilities for multiple equilibria illustrated in Example 1, considerably less variation

in equilibrium strategies arises for regular SPNE.

Denition 2. A SPNE (1 , 2 ) is regular if Ui (1 , 2 , t) < t T , i = 1, 2.

The remainder of this section is structured as follows. First I derive properties that regular SPNE must

satisfy. These properties are then used to dene a set of candidate strategy pairs that could be regular SPNE

in the innite-horizon centipede game. Finally, I derive sucient conditions for these candidate strategies

to, indeed, be regular SPNE.

In light of Theorem 1, any SPNE other than the trivial one must involve players sometimes randomizing

between D and R. The following result shows that in any regular SPNE, once one player randomizes, both

players randomize from that date forward. Thus, in every SPNE exhibiting cooperation, every decision node

has a strictly positive probability of being reached.

Lemma 1. If (1 , 2 ) is a regular SPNE, then for any t T

1. P (t+1) (t + 1) = 0 = P (t) (t) = 0;

2. P (t+1) (t + 1) = 1 = P (t) (t) = 1;

3. 0 < P (t) (t) < 1 = 0 < P (t+1) (t + 1) < 1.

Proof. I show the lemma is true for any t T1 . Analogous reasoning shows it is true for all t T2 . Fix

t T1 . If 2 (t + 1) = 0, then player 1s payo from choosing R at date t is u1 (t + 1) (because player 2 is sure

to end the game at t + 1); his payo from choosing D at date t is u1 (t). By Assumption 1 the latter strictly

exceeds the former, so subgame perfection requires that player 1 choose D at date t, that is, 1 (t) = 0,

establishing part 1. Next suppose 2 (t + 1) = 1. Then player 1s payo from choosing D at date t is u1 (t),

and his payo from choosing R at date t is at least u1 (t + 2) (because at date t + 2 player 1 could choose D).

By Assumption 1 the latter strictly exceeds the former, so subgame perfection requires that player 1 choose

R at date t, that is, 1 (t) = 1, establishing part 2. Finally, part 3 follows from parts 1 and 2.

B+

t pt

2 tT ,

1

tt0

= .

U2 (1 , 2 , t0 )

Similarly,

= .

7 But note that the player is not indierent between the choices of D and R!

If in a regular SPNE (1 , 2 ) a player randomizes between his actions at some date, then, because his

expected payos in all subgames are nite, he must be indierent between those actions. I use this indierence

condition to calculate the equilibrium continuation probabilities at each date. Consider the situation facing

player 2 at date t 1 T2 . Player 2s payo to choosing D is simply u2 (t 1). If he chooses R, then at

date t player 1 terminates the game with probability 1 1 (t), giving player 2 a payo of u2 (t); and if the

game continues, then player 2s payo is equal to the expected payo in the subgame starting at date t + 1.

From Lemma 1 it follows that player 2 is indierent between D and R at date t + 1, so player 2s expected

payo in the subgame beginning at date t + 1 is just u2 (t + 1). Therefore, player 2s expected payo from

choosing R is [1 1 (t)]u2 (t) + 1 (t)u2 (t + 1). For player 2 to be indierent between choosing D or R at

date t 1 it must be that

u2 (t 1) = [1 1 (t)]u2 (t) + 1 (t)u2 (t + 1),

which implies8

1 (t) =

1 (t)

u2 (t 1) u2 (t)

.

u2 (t + 1) u2 (t)

(2)

2 (t) =

2 (t)

u1 (t 1) u1 (t)

.

u1 (t + 1) u1 (t)

(3)

Lemma 2. Suppose (1 , 2 ) is a regular SPNE. If 0 < P (t ) (t ) < 1, then P (t) (t) =

P (t) (t) t > t .

I will refer to (

P (t) (t))t2 as the fundamental continuation probabilities. Player 1s fundamental continuation probabilities are (

1 (t))tT1 , and player 2s are (

2 (t))tT2 . I will denote by

2 player 2s strategy that

t3

has him continue according to his fundamental continuation probabilities; and, with slight abuse of notation,

when considering proper subgames I will denote by

1 a strategy for player 1 that has him continue according

to his fundamental continuation probabilities.

The next result combines Lemmas 1 and 2 to describe the set of strategy pairs that may constitute a

regular SPNE. Any regular SPNE other than the trivial one must coincide with the fundamental continuation

probabilities on all but some initial segment of the game. The critical feature of the equilibrium is the

8 Note

1 (1).

1 guarantees that

1 and

2 lie strictly between 0 and 1.

9 Assumption

continuation probability in the rst period where randomization is used. If this probability is small, then in

all earlier periods termination is chosen; if it is large, then in all earlier periods continuation is chosen.

Theorem 2. Suppose (1 , 2 ) is a regular SPNE. Dene t0 = inf{ t T | 0 < P (t) (t) < 1 }. Then either

1. t0 = and P (t) (t) = 0 t T ; or

2. t0 < and P (t) (t) =

P (t) (t) t > t0 , and

(a) if P (t0 ) (t0 ) >

P (t0 ) (t0 ), then P (t) (t) = 1 t < t0 ;

(b) if P (t0 ) (t0 ) <

P (t0 ) (t0 ), then P (t) (t) = 0 t < t0 ;

(c) if P (t0 ) (t0 ) =

P (t0 ) (t0 ), then either P (t) (t) = 0 t < t0 or P (t) (t) = 1 t < t0 .

The equilibrium given in part 1 of Theorem 2 is simply the trivial one. According to part 2 of the

theorem, equilibrium cooperationif possiblearises as follows. There is some date t0 that serves as the

starting point for randomization, with continuation there having probability at least

P (t0 ) (t0 ); at all earlier

dates players choose to continue with probability one, and at all later dates players choose to continue with

probability given by the fundamental continuation probability associated with that date.10,11 Part 2 of the

theorem describes strategy pairs that are candidates for being nontrivial regular SPNE; these strategy pairs

coincide with the set E dened next.

Denition 3. Dene E 1 2 as follows: (1 , 2 ) E if and only if (t0 , ) T (0, 1) such that

P (t0 ) (t0 ) = , P (t) (t) =

P (t) (t) t > t0 , and12

1. if >

P (t0 ) (t0 ), then P (t) (t) = 1 t < t0 ;

2. if <

P (t0 ) (t0 ), then P (t) (t) = 0 t < t0 ;

3. if =

P (t0 ) (t0 ), then either P (t) (t) = 0 t < t0 or P (t) (t) = 1 t < t0 .

It is worth emphasizing that the conditions in part 2 of Theorem 2 are only necessary for a strategy

pair to be a regular SPNE. But, as such, they narrow considerably the search for regular equilibria. For

these conditions to characterize a SPNE it must be that in every subgame, no player can increase his payo

10 A slight qualier is needed in the case of t = 1. Here, cooperation can arise with player 1 choosing continuation with

0

any positive probability. This is true because there is no earlier date at which a player 2 needs to be induced to continue with

positive probability. For the same reason, no fundamental continuation probability is dened at t = 1.)

11 It should be noted, too, that there may be nontrivial equilibria that do not exhibit cooperation. Such equilibria are described

by part 2(b) of Theorem 2.

12 If t = 1, then the comparisons below are void because

1 (1) is not dened. However, this is no matter because in this case

0

there are no earlier periods at which continuation probabilities need to be determined.

by switching to any pure strategy (as usual, it is sucient to consider deviations to pure strategies). To

facilitate such comparisons, it is helpful to dene the following families of pure strategies. For player i and

any t Ti , dene the (pure) strategy fit as follows: for any t Ti ,

fit (t )

if t < t

if t t,

(4)

i = 1, 2. Thus, the pure strategy f17 has player 1 choose R at each of his decision dates {1, 3, 5} and choose

D at each of his decision dates {7, 9, 11, . . . }. Additionally, dene fi by fi (t) 1 for every t Ti , i = 1, 2.

Thus, player i using strategy fi never chooses to end the game. When checking whether a strategy pair,

(1 , 2 ), constitutes a SPNE, it is sucient to check whether any pure strategies in these families provide

protable deviations for either player. Moreover, only pure strategies specifying termination at the current

date or lateror not at allneed be considered. These considerations yield the following.

Lemma 3. The strategy pair (1 , 2 ) is a SPNE if and only if

and

U1 (1 , 2 , t) U1 (f1s , 2 , t)

s T1 {} with s t, t T1 ,

U2 (1 , 2 , t) U2 (1 , f2s , t)

s T2 {} with s t, t T2 .

The fundamental continuation probabilities are constructed so that the player with the move at date t

is indierent between stopping there or continuing, with the plan to stop at t + 2 if that date is reached. It

is plausible that by extension he will also be indierent between stopping at date t or continuing at both t

and t + 2 (if reached), with the plan to stop at date t + 4 if that date is reached. The following lemma shows

this is indeed the case (the proof is sketched in the Appendix).

Lemma 4. Suppose (1 , 2 ) E and suppose 0 < P (t0 ) (t0 ) < 1.

1. If t0 T1 then U1 (f1t , 2 , t0 ) = u1 (t0 ) t T1 , t t0 ; and U1 (f1 , 2 , t0 ) u1 (t0 ).

2. If t0 T2 then U2 (1 , f2t , t0 ) = u2 (t0 ) t T2 , t t0 ; and U2 (1 , f2 , t0 ) u2 (t0 ).

Lemma 4 says that for any strategy pair in E, once randomization begins a player is indierent between

terminating when he has a move or using any pure strategy that species termination at some later date,

and any strategy that species termination at any of his decision nodes in the subgame is then at least

as desirable as choosing never to terminate. Moreover, if player i chooses never to terminate (that is, he

uses pure strategy fi ), he might receive a strictly lower expected payo because either the other player

10

terminates the game or the game never terminates. To capture this probability, for any t T and any

P (t) , dene the nontermination probability as

(t | )

(t + 2k).

k=0

Thus, in the subgame beginning at t, player P (t) using strategy P (t) places probability (t | ) on pure

strategy fP(t) . If in the subgame beginning, say, at t T2 , players strategies agree with

1 and

2 , then the

probability that the game does not terminate equals (t + 1 |

1 ) (t |

2 ).

For strategy pairs in E, the following lemma shows that the signs of nontermination probabilities and

payo comparisons in subgames beginning with randomization are the same as those signs derived from the

subgames starting at dates 2 and 3.

Lemma 5. Suppose (1 , 2 ) E and suppose 0 < P (t0 ) (t0 ) < 1.

1. If t0 T1 , then (t0 | 1 ) > 0 (3, |

1 ) > 0

and U1 (f1 , 2 , t0 ) < u1 (t0 ) U1 (f1 ,

2 , 3) < u1 (3).

2. If t0 T2 , then (t0 | 2 ) > 0 (2, |

2 ) > 0

and U2 (1 , f2 , t0 ) < u2 (t0 ) U2 (

1 , f2 , 2) < u2 (2).

Observe that if (1 , 2 ) E and t T1 are such that 0 < 1 (t) < 1, then Lemma 4 implies

U1 (1 , 2 , t) = [1 (t | 1 )]u1 (t) + (t | 1 ) U1 (f1 , 2 , t)

= u1 (t) (t | 1 ) u1 (t) U1 (f1 , 2 , t) .

(5)

From Lemma 4 it follows that that for strategy pairs in E, if randomization has begun by t T1 , then

(t | 1 ) u1 (t) U1 (f1 , 2 , t) 0. Therefore, (5) implies that in such cases, 1 is a best response to 2

if and only if (t | 1 ) u1 (t) U1 (f1 , 2 , t) = 0. And by Lemma 5 it suces to check this condition is

satised at t = 3. Analogous considerations apply to player 2, yielding the following necessary and sucient

conditions for existence of nontrivial regular SPNE.

Theorem 3. (1 , 2 ) E is a regular SPNE if and only if the following conditions are satised:

2 , 3)] = 0, and

1. (3 |

1 ) [u1 (3) U1 (f1 ,

2. (2 |

2 ) [u2 (2) U1 (

1 , f2 , 2)] = 0.

11

In the next theorem, the nontermination probabilities alone provide a key to determining whether there

exist regular SPNE exhibiting cooperation.

Theorem 4.

1. If (3, |

1 ) = 0 and (2, |

2 ) = 0, then the set of nontrivial regular SPNE is given by E.

2. If (3, |

1 ) > 0 and (2, |

2 ) > 0, then the unique regular SPNE is the trivial one.

Part 1 of Theorem 4 follows directly from Theorem 3. The proof of Theorem 4 is given in the Appendix,

but the central ideas are the following. The assumptions of part 1 of Theorem 4 imply that for any (1 , 2 )

E, in every subgame both players assign zero probability to playing the potentially dominated strategy f1

or f2 . So by Lemma 4, once randomization begins, player i has no pure strategy that he strictly prefers

over i in the remaining subgame. In contrast, the assumptions of part 2 of Theorem 4 imply that for any

(1 , 2 ) E, for all t suciently large that (1 , 2 ) agrees with (

1 ,

2 ), the subgame beginning at t will

not terminate with probability one; but this is not optimal for a player because termination at one of his

own decision nodes yields a strictly positive payo while nontermination yields a payo of zero. Theorem 4

leaves unanswered the question of whether nontrivial regular SPNE exist when either (i) (3, |

1 ) > 0 and

(2, |

2 ) = 0 or (ii) (3, |

1 ) = 0 and (2, |

2 ) > 0. As shown below, in such cases regular SPNE might or

might not exist, depending on additional properties of the payo functions.

By reference to players nontermination probabilities implied by their fundamental continuation probabilities, Theorem 4 determines the existence of nontrivial regular SPNE. However, it would be more convenient,

if possible, to determine existence on nontrivial regular SPNE by reference to the basic elements of the

centipede game, namely, players payo functions. The following lemma gives sucient conditions for the

nontermination probabilities to be zero or strictly positive.

Lemma 6.

1. If u1 is unbounded, then (2 |

2 ) = 0. If u2 is unbounded, then (3 |

1 ) = 0.

2. If u1 is bounded and supsT

2 ) > 0.

/ 1 u1 (s) < supsT1 u1 (s), then (2 |

If u2 is bounded and supsT

1 ) > 0.

/ 2 u2 (s) < supsT2 u2 (s), then (3 |

Part 1 of Theorem 4 and part 1 of Lemma 6 yield the following corollary.

Theorem 5. If u1 and u2 are unbounded, then the set of nontrivial regular SPNE is given by E.

12

An immediate corollary to part 2 of Theorem 4 and part 2 of Lemma 6 is that if ui is bounded and

supsT

/ i ui (s) < supsTi ui (s), i = 1, 2, then nontrivial SPNE do not exist. The following result derives this

conclusion under slightly weaker assumptions, requiring only one players payo function to be bounded.

Theorem 6. Suppose supsT

/ 1 u1 (s) < supsT1 u1 (s) and supsT

/ 2 u2 (s) < supsT2 u2 (s). If either u1 or u2

is bounded, then the unique regular SPNE is the trivial one.

Proof. Let (1 , 2 ) E, and suppose u1 is bounded (the case in which u2 is bounded is proved analogously).

Because u2 is increasing on T2 and (1 , 2 ) E, the assumption supsT

/ 2 u2 (s) < supsT2 u2 (s) implies there

exists t T2 such that (i) u2 (t) > supsT

P (t) (t) for all

/ 2 u2 (s) for all t T2 with t t and (ii) P (t) (t) =

t t. Fix t0 T2 with t0 t. If in the subgame beginning at t0 player 2 plays f2 , then the game either

does not terminate or it terminates on T1 , and both possibilities yield player 2 a realized payo strictly less

than u2 (t0 ), his payo from terminating at t0 . Therefore, in the subgame beginning at t0 , f2 is a strictly

dominated strategy; but by Lemma 6, strategy

2 and so too 2 in the subgameplaces strictly positive

probability on strategy f2 . Consequently, (1 , 2 ) is not a SPNE.

The exact conditions on payos ensuring there exist nontrivial regular SPNE seem elusive. First, consider the role of nontermination probabilities, which are themselves determined by players payos. From

Theorem 4 the ambiguous case arises, for example, if (3 |

1 ) = 0 and (2 |

2 ) > 0. Suppose u1 and u2

satisfy the assumptions of Theorem 6, with u1 bounded and u2 unbounded. Lemma 6 implies (3 |

1 ) = 0

and (2 |

2 ) > 0; and by Theorem 6 the only regular SPNE is the trivial one. However, in Example 2 below,

there exist nontrivial regular SPNE even though (3 |

1 ) = 0 and (2 |

2 ) > 0. Next, consider the role of

boundedness of players payos. If both players payos are unbounded, then by Theorem 4 it follows that

there exist nontrivial regular SPNE. So boundedness of at least one players payo function is necessary for

the unique SPNE to be the trivial one. But as the following example shows, even if both players payos are

bounded, equilibrium cooperation can still arise.

Example 2 (Cooperation with bounded payos).

Consider the innite-horizon centipede game in which

1+t

u1 (t) =

if t T1

and

if t

/ T1 ,

13

1

t

u2 (t) =

t+3

1

t2 1

if t T2

if t

/ T2 .

It is readily veried that this game satises Assumption 1. This game almost satises the assumptions of

Theorem 6: both payo functions are bounded but only u1 satises the supremum condition in the theorem.13

Furthermore, every strategy pair in E is a regular SPNE. This is shown by verifying conditions 1 and 2 of

Theorem 3 are satised. For any t T1 with t 3,

1 (t) = 1/2, which implies (3 |

1 ) = 0, so condition 1

of Theorem 3 is satised. On the other hand, (by Lemma 7 in the Appendix) (2 |

2 ) = u1 (1) > 0. In order

for (1 , 2 ) to be a SPNE, it now suces to show that u2 (2) = U2 (

1 , f2 , 2). To see that this is indeed the

case, observe that

U2 (1 , f2 , 2) = lim

N

u2 (2 + 2k + 1)[1 1 (2 + 2k + 1)]

k1

1 (2 + 2j + 1)

(6)

j=0

k=0

N

N

k1

= lim

u2 (4 + 2N )

1 (3 + 2j) +

u2 (3 + 2k)[1 1 (3 + 2k)]

1 (3 + 2j)

N

j=0

j=0

k=0

u2 (4 + 2N )

1 (3 + 2j)

j=0

= lim

U2 (1 , f24+2N , 2) u2 (4 + 2N )

1 (3 + 2j)

N

(7)

j=0

= u2 (2) 1 (3 |

1 )

(8)

= u2 (2),

(9)

where the limit in (6) exists because u2 is bounded; (7) follows from the denition of U2 (1 , f24+2N , 2); the

limit in (8) follows from Lemma 4, convergence of u2 to 1, and the denition of (3 |

1 ); and (9) follows

from (3 |

1 ) = 0. Therefore, U2 (1 , f2 , 2) = u2 (2), implying condition 2 of Theorem 3 is satised. It now

follows from Theorem 3 that in this example the nontrivial regular SPNE are given by E.

Further illustrating the diculty of nding exact conditions under which there are no SPNE exhibiting

cooperation, the following example continues with both players having bounded payos, but neither payo

function satises the supremum condition of Theorem 6. Nevertheless, the unique SPNE is the trivial one.

Thus, the supremum condition is not essential to nonexistence of regular SPNE exhibiting cooperation.

13 That

is, supsT

/ 1 u1 (s) < supsT1 u1 (s) but supsT

/ 2 u2 (s) = supsT2 u2 (s).

14

Example 3.

Finally, x (0, 1) and consider the innite-horizon centipede game in which

1 2t

u1 (t) = 0

1 t

if t T1

and

if t = 2

u2 (t) =

if t

/ T1 , t > 2,

1 2t

if t T2

1 t

if t

/ T2 .

It is readily veried that this game satises Assumption 1. Also, both payo functions are bounded but

neither satises the supremum condition of Theorem 6. Furthermore, it is the case that

P (t) (t) =

1 t2

1 t+2

t > 2.

(t |

P (t) ) = lim

N

P (t) (t + 2k)

k=0

N

1 t+2k2

N

1 t+2k+2

= lim

k=0

= lim

1 t2

1 t

1 t+2

1 t+4

t+2

t+4

t+6

1

1

1

1 t+8

1 t+2N 8 1 t+2N 6

1 t+2N 4

1 t+2N 2

t+2N

4

t+2N

2

t+2N

1

1

1

1 t+2N +2

(1 t2 )(1 t )

N (1 t+2N )(1 t+2N +2 )

= lim

= (1 t2 )(1 t )

> 0.

Thus, in every subgame each players fundamental continuation probabilities leave a positive probability of

not choosing to terminate. So part 2 of Theorem 4 implies this games unique SPNE is the trivial one.

15

Examples

This section provides several examples of the centipede game, beginning with an innite-horizon version of

Rosenthals original game.

4.1

u1 (t) =

t 1

if t T1

t 1 2

if t T2

and

u2 (t) =

t 1

if t T1

t 1 + 2

if t T2 .

For = 1, the rst ten stages of this game are identical to Rosenthals game shown in Figure 1. Assumption 1

requires that ui (t) > ui (t+1) for all t Ti , i = 1, 2; this condition is satised if and only if > 1/2. Therefore,

assume > 1/2. Both players payos are unbounded, so Theorem 4 implies the set of nontrivial regular

SPNE is given by E. Equations (2) and (3) show that the fundamental continuation probability at date t 2

is given by

=

21

2+1 .

Thus, for example, for Rosenthals case of = 1, the strategies that have each player

terminate with probability 2/3 in each period form a regular SPNE exhibiting cooperation.

4.2

Consider two risk neutral players who oversee a project whose value is given by the project value function

Q. Player 1 can terminate the project in period 1, getting for himself share of the projects value, Q(1),

or he can continue the project for a period. If he continues the project, then at date 2, player 2 decides

whether to end the project, claiming for himself share of the projects value, Q(2).14 The projects value

grows every period until the game is terminated. If player 1 terminates the game, he receives share of the

projects value and player 2 receives share 1 ; if player 2 terminates the game, he receives share and

player 1 receives share 1 . In this scenario the realized payos to players 1 and 2 are

Q(t)

u1 (t) =

(1 )Q(t)

if t T1

and

if t T2

u2 (t) =

(1 )Q(t)

if t T1

Q(t)

if t T2 ,

14 An extreme case occurs when = = 1. Such might arise with two criminals who take turns guarding their everincreasing stockpile of valuables illegally obtained. Either might run o with the loot when it is his turn for guard duty. When

cooperation arises, each knows the other hopes to leave him with nothing; but it is the prospect of a suciently larger future

payday that may keep each from certain departure when it is his turn as guard.

16

I rst dispense with the case of a bounded project value function. Suppose the least upper bound of Q

< . For player 1,

is Q

> (1 )Q

= sup u1 (t),

sup u1 (t) = Q

tT1

tT2

where the inequality follows from Assumption 1 and the assumption that Q increases over time. Similarly,

suptT2 u2 (t) > suptT1 u2 (t). Thus, for all centipede games based on increasing bounded project value

functions satisfying Assumption 1, Theorems 6 implies that the only SPNE is the trivial one.

Next suppose the increasing project value function Q is unbounded and satises Assumption 1. Theorem 5

implies there exist SPNE exhibiting cooperation for any , (0, 1], provided Assumption 1 is satised.

From (2) and (3) the fundamental continuation probabilities are

1 (t)

Q(t 1) (1 )Q(t)

t T1 , t 3,

Q(t + 1) (1 )Q(t)

and

2 (t)

Q(t 1) (1 )Q(t)

t T2 . (10)

Q(t + 1) (1 )Q(t)

I next determine how changes in the shares and aect the fundamental continuation probabilities. It is

easily calculated that

1 (t)

Q(t)[Q(t + 1) Q(t 1)]

>0

=

[Q(t + 1) (1 )Q(t)]2

(11)

1 (t)

(1 )Q(t)[Q(t + 1) Q(t 1)]

> 0,

=

[Q(t + 1) (1 )Q(t)]2

(12)

and

where the inequalities follow from Assumption 1. To see why an increase in either players share increases

a players fundamental continuation probability, consider the situation facing player 2 at date t 1 T2 .

An increase in does not aect player 2s payo from terminating at t 1 but it does reduce the his future

expected payo as termination on T1 becomes less desirable. To keep player 2 indierent between terminating

at t 1 and continuing, it must be that termination on T1 in the future becomes less likely, and this is done

by increasing

1 (t). Next consider a 1% increase in . This increases player 2s payo from termination at

t 1 by 1%. However, because the future expected payo from continuation involves a mixture of payos

on T1 and on T2 , that expected payo increases by less than 1%. To maintain player 2s indierence about

termination at t 1, it must be that termination on T1 (the less desirable termination nodes for player 2)

becomes less likely, and this is done by increasing player 1s continuation probability,

1 (t).

17

The following proposition shows that if the growth rate of the project value function changes monotonically, then so too do each players fundamental continuation probabilities.15

Proposition 1. Suppose Q is unbounded. If Q exhibits a monotonically increasing or decreasing growth rate,

then for each player the fundamental continuation probabilities are correspondingly decreasing or increasing.

Proof. The assumption of a monotonically increasing growth rate means

Q(t + 1)

Q(t + 2)

Q(t)

Q(t + 1)

t T.

(13)

1 (t) =

Q(t 1) (1 )Q(t)

Q(t + 1) (1 )Q(t)

Q(t 1)

(1 )

Q(t)

=

Q(t + 1)

(1 )

Q(t)

Q(t + 1)

(1 )

Q(t + 2)

Q(t + 1)

(1 )

Q(t)

Q(t + 1)

(1 )

Q(t + 2)

Q(t + 3)

(1 )

Q(t + 2)

Q(t + 2)

Q(t)

because

Q(t 1)

Q(t + 1)

because

Q(t + 1)

Q(t + 3)

Q(t + 2)

Q(t)

Q(t + 1) (1 )Q(t + 2)

Q(t + 3) (1 )Q(t + 2)

=

1 (t + 2).

Thus, if the project value function exhibits a growth rate that increases with time, then in any SPNE

exhibiting cooperation, once randomization begins, player 1s continuation probabilities decrease over time.

By analogous reasoning, the same is true for player 2. Similarly, if the project value function exhibits a

decreasing growth rate, then each players fundamental continuation probabilities increase with time.

15 Of

course, nonmonotonicity in the growth rate of Q can lead to nonmonotonicity in players continuation probabilities.

18

To conclude this subsection, consider the case in which the project value grows by factor > 1 per

period:16

Q(t) = t1 .

(14)

In this case, growth of Q and Assumption 1 are equivalent to the following: , , and satisfy (i) > 1,

(ii) > (1 ), and (iii) > (1 ). The growth rate of Q is constant, so Proposition 1 implies that

players fundamental continuation probabilities are constant. In particular, (2) and (3) yield

1 (t) =

(1 )

t T1 , t 3,

( (1 ))

and

2 (t) =

(1 )

t T2 .

( (1 ))

(15)

By Theorem 2, regular SPNE other than the trivial one must eventually coincide with (

1 ,

2 ). In such

periods, the eect of increased growth on continuation probabilities can now be checked. It is easily veried

that

1 / < 0 and

2 / < 0.17 The intuition is clear: as increases, future project values increase

relative to the current value; therefore, to keep a player indierent between continuing and terminating the

game, continuation probabilities are reduced so that the game ends sooner.

4.3

Consider two players taking turns contributing to the funding of a public good. At each turn a player can

contribute or not; if no contribution is made, the funding of the public good is terminated. If funding

terminates with player i having contributed ci , then the realized payo to player i is ui = (c1 + c2 ) ci ,

i = 1, 2. Assume that (1/2, 1), so it is socially ecient to fund the good, but no player would do so

alone. (Both Lockwood and Thomas (2002) and Marx and Matthews (2000) allow such payos, though

they assume at each date contributions are made simultaneously.) Let (at )tT be any sequence of strictly

positive numbers. If in period t player P (t) chooses to contribute to the public good, he contributes amount

at ; otherwise the game terminates.18 This dynamic contribution game with xed contribution levels (at )tT

16 Aumann (1992) and McKelvey and Palfrey (1992) consider specic nite-horizon versions of this centipede game with

project value function (14). Megiddos (1986) share-or-quit game is practically the same as this centipede game with = 10

and = = 1.

17 For example,

(1 )(1 + 2 ) 2

(1 )(1 + 2 ) 2(1 ) 2

(1 )(1 2 )

1

=

<

= 2

< 0,

2 ( (1 ))2

2 ( (1 ))2

( (1 ))2

where the inequalities follow from Assumption 1.

18 Though not required by the centipede game, it is often supposed that there is a nite funding target, say X . In this case

at = X .

we might suppose

19

can be represented by an innite-horizon centipede game. If, additionally, at+1 /at > (1 )/ for all t T ,

then this centipede game satises Assumption 1. This condition guarantees that a players sacrice from

contributing in one period would be more than fully oset by the other players contribution in the next. (If

this condition is never satised, then players are sure not to contribute.) As a special case, suppose successive

ratios are bounded (at )tT away from (1 )/; that is, there exists > 1 such that at+1 /at > (1 )/

for all t T . The associated fundamental continuation probabilities are19

P (t) (t) =

at1

1

at

t 2.

Because

P (t) (t) 1/ < 1 for every t 2, it follows that (t |

P (t) ) = 0 for all t 2. Therefore, Theorem 4

guarantees that the set of nontrivial regular SPNE is given by E. In particular, there exist regular SPNE

exhibiting cooperation.

Appendix

Sketch of the proof of Lemma 4. Here I simply illustrate the proof for part 1. Part 2 is shown analogously.

Suppose t0 T1 is such that 0 < P (t0 ) (t0 ) < 1. By the denition of E, 2 (t) =

2 (t) t T2 , t > t0 . To

illustrate the proof, I will show that U1 (f1t0 +6 , 2 , t0 ) = u1 (t0 ) (the general case is shown by induction). By

denition of the fundamental continuation probabilities

2 (t0 + 1),

2 (t0 + 3) and

2 (t0 + 5), it follows that

u1 (t0 ) = [1 2 (t0 + 1)]u1 (t0 + 1) + 2 (t0 + 1)u1 (t0 + 2)

u1 (t0 + 2) = [1 2 (t0 + 3)]u1 (t0 + 3) + 2 (t0 + 3)u1 (t0 + 4)

(16)

and

(17)

(18)

Furthermore, substituting (17) into (16) and (18) into (17), we obtain

u1 (t0 ) = [1 2 (t0 + 1)]u1 (t0 + 1) + 2 (t0 + 1)u1 (t0 + 2)

= [1 2 (t0 + 1)]u1 (t0 + 1) + 2 (t0 + 1) [1 2 (t0 + 3)]u1 (t0 + 3) + 2 (t0 + 3)u1 (t0 + 4)

19 To obtain these continuation probabilities, suppose, for example, that t T . The dierence u (t 1) u (t) is due to

2

1

1

player 1s contributing in period t1, yielding u1 (t1)u1 (t) = (at1 at1 ) = (1)at1 . The dierence u1 (t+1)u1 (t)

results solely from player 2 having contributed in period t, yielding u1 (t + 1) u1 (t) = at . Now use (3) to calculate player 2s

fundamental continuation probability at t.

20

+ 2 (t0 + 1)2 (t0 + 3) [1 2 (t0 + 5)]u1 (t0 + 5) + 2 (t0 + 5)u1 (t0 + 6)

= [1 2 (t0 + 1)]u1 (t0 + 1) + 2 (t0 + 1)[1 2 (t0 + 3)]u1 (t0 + 3)

+ 2 (t0 + 1)2 (t0 + 3)[1 2 (t0 + 5)]u1 (t0 + 5) + 2 (t0 + 1)2 (t0 + 3)2 (t0 + 5)u1 (t0 + 6)

= U1 (f1t0 +6 , 2 , t0 ).

Now, consider U1 (f1 , 2 , t0 ). We have

U1 (f1 , 2 , t0 ) = lim inf

N

N

k1

2 (t0 + 2j + 1)

j=0

k=0

lim inf u1 (t0 + 2N + 2)

2 (t0 + 2j + 1)

N

j=0

N

k1

j=0

k=0

2 (t0 + 2j + 1)

N

= u1 (t0 ),

where the inequality follows because Assumption 1 and t0 + 2N + 2 T1 imply u1 (t0 + 2N + 2) > 0; the

second equality follows because the (previous) term in braces is U1 (f1t0 +2N +2 , 2 , t0 ); and the last equality

follows because U1 (f1t0 +2k , 2 , t0 ) = u1 (t0 ) for any integer k 0, as established in part 1.

Proof of Lemma 5. I prove part 2 of the lemma. Part 1 is proven similarly. Let t0 = 2 + 2M T2 , where M

is a nonnegative integer. Observe that for any t T2 , t > t0 , it is the case that 2 (t) =

2 (t).

First, consider the nontermination probabilities. We have

(2 + 2M | 2 ) = 2 (2 + 2M )

2 (2 + 2M + 2k)

k=1

= 2 (2 + 2M )

k=1

21

2 (2 + 2M + 2k)

M

k=0

k=0

2 (2 + 2k)

2 (2 + 2k)

k=0

2 (2 + 2M )

M

2 (2 + 2M )

2 (2 + 2k)

(2 |

2 ),

2 ) > 0.

Next, consider the payo comparison. Observe that

u2 (2) = U2 (

1 , f22M +2 , 2)

= u2 (2M + 2)

M

1

1 (2 + 2j + 1)

j=0

M

1

u2 (2 + 2k + 1)[1

1 (2 + 2k + 1)]

k1

(19)

1 (2 + 2j + 1)

j=0

k=0

and

U2 (

1 , f2 , 2) = lim inf

N

N

u2 (2 + 2k + 1)[1

1 (2 + 2k + 1)]

k1

1 (2 + 2j + 1).

j=0

k=0

U2 (

1 , f2 , 2)

N

N

u2 (2 + 2k + 1)[1

1 (2 + 2k + 1)]

M

1

1 (2 + 2j + 1)

j=0

k=M

u2 (2M + 2)

k1

M

1

j=0

1 (2 + 2j + 1)

1 (2 + 2j + 1)

j=0

k1

N

lim inf

u2 (2 + 2k + 1)[1

1 (2 + 2k + 1)]

1 (2 + 2j + 1)

N

j=M

k=M

u2 (2M + 2)

22

(20)

M

1

1 (2 + 2j + 1)

j=0

k1

N

lim inf

u2 (t0 + 2k + 1)[1 1 (t0 + 2k + 1)]

1 (t0 + 2j + 1)

N

j=0

k=0

u2 (t0 )

M

1

=

1 (2 + 2j + 1) U2 (1 , f2 , t0 ) u2 (t0 ) .

j=0

Because

1 (t) > 0 t T1 , t 3, it follows that U2 (

1 , f2 , 2) < u2 (2) U2 (1 , f2 , t0 ) < u2 (t0 ).

Proof of Theorem 3. Fix (1 , 2 ) E, and dene t0 min{ t T | 0 < P (t) (t) < 1 }. By construction of

the set E, t0 is well-dened. To simplify notation, I will consider only the case where t0 T2 . (A similar

proof applies when t0 T1 .)

=: First suppose (1 , 2 ) is a regular SPNE. I will show that conditions 1 and 2 of the theorem are

satised. Fix t T2 , t > t0 . Then P (s) (s) =

P (s) (s) s t. By Lemma 4 it follows that (t | 2 ) u2 (t)

U2 (1 , f2 , t) 0. Because playing 2 must be at least as good for player 2 as immediate termination at

date t, it follows that

u2 (t) U2 (1 , 2 , t)

= u2 (t) (t | 2 ) u2 (t) U2 (1 , f2 , t) ,

where the equality follows analogously to (5). Therefore, (t | 2 ) u2 (t) U2 (1 , f2 , t) 0. But Lemma 4

implies (t | 2 ) [u2 (t) U2 (1 , f2 , t)] 0, so it must be that (t | 2 ) [u2 (t) U2 (1 , f2 , t)] = 0; and by

Lemma 5 this equality is satised if and only if (2 |

2 ) [u2 (2) U2 (

1 , f2 , 2)] = 0. Similarly, it must be

that (3 |

1 ) [u1 (3) U1 (f1 ,

2 , 3)] = 0.

=: Now suppose conditions 1 and 2 of the theorem are satised. I will show that (1 , 2 ) is a regular

SPNE. First consider t T2 , t t0 (recall t0 T2 ). If t T2 , then, analogously to (5),

U2 (1 , 2 , t) = u2 (t) (t | 2 ) u2 (t) U2 (1 , f2 , t)

= u2 (t),

23

where the second equality follows from condition 2 of the theorem together with Lemma 5. Consequently,

in light of Lemma 4, player 2 has no alternative strategy that improves upon 2 in the subgame beginning

at t. Similarly, if t T1 it can be shown that player 1 has no alternative strategy that improves upon 1 in

the subgame beginning at t.

Next consider the subgame beginning at t0 1 T1 . By the denition of t0 , it follows that either

1 (t0 1) = 0 or 1 (t0 1) = 1. If 1 (t0 1) = 0, then by denition of elements of E, it must be that

2 (t0 )

2 (t0 ), implying player 1 weakly prefers termination at t0 1, so 1 (t0 1) = 0 is indeed optimal

in the subgame beginning at t0 1. Furthermore, by denition of elements of E, it is then also the case

that P (t) (t) = 0 t < t0 1. Consider the subgame beginning at t0 2 T2 . Because 2 (t0 2) = 0, it

follows that U2 (1 , 2 , t0 2) = u2 (t0 2). Furthermore, because player 1 will terminate at t0 1 if given

the chance,

U2 (1 , f2s , t0 2) =

u2 (t0 2) if s = t0 2

Thus, because u2 (t0 2) > u2 (t0 1), in the subgame beginning at t0 2, player 2 has no pure strategy that

improves upon 2 . This reasoning continues back to the beginning of the game, establishing that P (t) (t) = 0

is optimal at all t < t0 1. Consequently, if 1 (t0 1) = 0, then the strategy pair (1 , 2 ) is indeed a regular

SPNE.

If, instead, 1 (t0 1) = 1, then by denition of elements of E, it must be that 2 (t0 )

2 (t0 ), in which case

player 1 weakly prefers continuation at t0 1, so 1 (t0 1) = 1 is indeed optimal in the subgame beginning

at t0 1. Furthermore, by denition of elements of E, it is then also the case that P (t) (t) = 1 t < t0 1.

Consider the subgame beginning at t0 2 T2 . Under (1 , 2 ) the game is sure to reach date t0 , at which

point player 2s payo will be U2 (1 , 2 , t0 ) = u2 (t0 ), as above. Therefore, by Lemma 4

U2 (1 , f2s , t0 2) =

u2 (t0 2)

if s = t0 2

U2 (1 , f2s , t0 )

if s T2 , s t0

u2 (t0 2)

if s = t0 2

u2 (t0 )

if s T2 , s t0 .

Also by Lemma 4, playing f2 does not increase player 2s payo. Thus, because u2 (t0 2) < u2 (t0 ), in the

subgame beginning at t0 2, player 2 has no pure strategy that improves upon 2 . This reasoning continues

24

back to the beginning of the game, establishing that P (t) (t) = 1 is optimal at all t < t0 1. Consequently,

if 1 (t0 1) = 1, then the strategy pair (1 , 2 ) is indeed a regular SPNE.

It only remains to show that the SPNE (1 , 2 ) is regular. Fix t T2 . If t t0 then U1 (1 , 2 , t)

U1 (1 , 2 , t0 +1) = u1 (t0 +1) and U2 (1 , 2 , t) u2 (t0 ). Similarly, if t > t0 , then U1 (1 , 2 , t) U1 (1 , 2 , t+

1) = u1 (t + 1) and U2 (1 , 2 , t) = u2 (t). Thus, t T2 , U1 (1 , 2 , t) and U2 (1 , 2 , t) are nite. Similarly,

t T1 , U1 (1 , 2 , t) and U2 (1 , 2 , t) are nite. Thus, the SPNE (1 , 2 ) is regular.

Proof of Theorem 4. Part 1 follows immediately from Theorem 3.

Next consider part 2 of the theorem. Fix (1 , 2 ) E, and suppose (3, |

1 ) > 0 and (2, |

2 ) > 0.

Dene t0 min{ t T | 0 < P (t) (t) < 1 }. I consider only the case where t0 T2 (the case t0 T1 is

handled similarly). If player 2 terminates the game at t0 he gets the payo u2 (t0 ). I will show that 2 is

strictly dominated by immediate termination. Observe that

U2 (1 , f2 , t0 ) = lim inf

N

N

k1

1 (t0 + 2j + 1)

j=0

k=0

= lim inf u2 (t0 + 2N + 2)

1 (t0 + 2j + 1)

N

j=0

N

k1

1 (t0 + 2j + 1)

j=0

k=0

u2 (t0 + 2N + 2)

N

j=0

1 (t0 + 2j + 1)

= lim inf U2 (1 , f2t0 +2N +2 , t0 ) u2 (t0 + 2N + 2)

1 (t0 + 2j + 1)

N

j=0

lim inf U2 (1 , f2t0 +2N +2 , t0 ) u2 (t0 + 2)

1 (t0 + 2j + 1)

N

j=0

1 )

< u2 (t0 ),

where the last equality follows from Lemma 4 and the denition of (t0 + 1 |

1 ), and the last inequality

1 ) > 0. Because (2, |

2 ) > 0, it follows that in the subgame

follows because u2 (t0 + 2) > 0 and (t0 + 1 |

25

beginning at t0 , player 2 places strictly positive probability on the strictly dominated pure strategy f2 .

Hence, against 1 , play of 2 cannot be optimal for player 2 in the subgame beginning at t0 . Therefore,

(1 , 2 ) is not a SPNE.

Lemma 7. Consider an innite-horizon centipede game in which ui (t) = 0 for all i

/ Ti , i = 1, 2. Then

u2 (t 1)

N u2 (t + 1 + 2N )

(t |

1 ) = lim

t T1 with t 3

and

u1 (t 1)

N u1 (t + 1 + 2N )

(t |

2 ) = lim

for any t T2 .

(t |

1 ) =

1 (t + 2k)

k=0

= lim

N

1 (t + 2k)

k=0

N

u2 (t + 2k 1)

N

u2 (t + 2k + 1)

= lim

k=0

= lim

u2 (t 1) u2 (t + 1) u2 (t + 3)

u2 (t + 2N 3) u2 (t + 2N 1)

u2 (t + 1) u2 (t + 3) u2 (t + 5)

u2 (t + 2N 1) u2 (t + 2N + 1)

u2 (t 1)

.

N u2 (t + 2N + 1)

= lim

Proof of Lemma 6. I prove the lemma for player 1. Analogous reasoning establishes it for player 2.

Step 1. I rst establish the lemma in the case where u2 (t) = 0 t

/ T2 . Because 2 T2 and 4 + 2N T2

it follows from Lemma 7 that

(3 |

1 )

= 0

if u2 is unbounded on T2

> 0

if u2 is bounded on T2 .

Step 2. Suppose u2 is unbounded on T2 . Dene the function v2 (t) = u2 (t) B for any t T ; then

26

v2 (t) 0 t

/ T2 . Observe that

1 (t) =

u2 (t 1) u2 (t)

u2 (t + 1) u2 (t)

v2 (t 1) v2 (t)

v2 (t + 1) v2 (t)

v2 (t 1)

v2 (t + 1)

1 (t),

1 for any t T1 , it

where the last line serves to dene the alternate strategy

1

follows that

1)

(3 |

1 ) (3 |

v2 (2)

N v2 (4 + 2N )

= lim

(21)

= 0,

(22)

where (21) follows from exactly the same construction used to prove Lemma 7, and (22) follows because v2

is unbounded on T2 . This establishes part 1 of Lemma 6.

Step 3. Suppose u2 is bounded on T2 and satises Assumption 1, and u

2 supsT

/ 2 u2 (s) < limsT2 u2 (s).

Then B u

2 < , where the rst inequality follows from Assumption 1 and the second from the assumption

that u2 is bounded. Because u2 is strictly increasing on T2 and limsT2 u2 (s) > u

2 , it follows that t T1

such that u2 (s) > u

2 s T2 , s t 1.

Dene the function v2 by v2 (s) = u2 (s) u

2 s T . Note that v2 (s) > 0 v2 (s ) s T2 , s

/ T2 ,

with s, s t 1. Observe that s T1 , with s t,

1 (s) =

u2 (s 1) u2 (s)

u2 (s + 1) u2 (s)

v2 (s 1) v2 (s)

v2 (s + 1) v2 (s)

v2 (s 1)

v2 (s + 1)

1 (s),

27

1 (s) for any

where the last line serves to dene the alternate strategy

1 (s)

s T1 with s t, it follows that

1)

(t |

1 ) (t |

v2 (t 1)

N v2 (t + 1 + 2N )

= lim

(23)

> 0,

(24)

where (23) follows from exactly the same construction used to prove Lemma 7, and (24) follows because v2 is

bounded on T2 . This establishes part 2 of Lemma 6, (t |

1 ) > 0, for t T1 , t t. For t t with 3 t < t,

the relationship

(3 |

1 ) = (t |

1 )

1 (s) > 0

sT1 ,

3s<t

References

Abreu, Dilip (1986), Extreme equilibria of oligopolistic supergames, Journal of Economic Theory 39: 191

225.

Abreu, Dilip (1988), On the theory of innitely repeated games with discounting, Econometrica 56: 383

396.

Admati, Anat R., and Motty Perry (1991), Joint projects without commitment, Review of Economic Studies

58, 259276.

Aumann, Robert J. (1992), Irrationality in game theory, in Economic Analysis of Markets and Games:

essays in honor of Frank Hahn, Partha Dasgupta, Douglas Gale, Oliver Hart, and Eric Maskin eds.,

MIT Press, 1992.

Aumann, Robert J. (1995), Backward induction and common knowledge of rationality, Games and Economic Behavior 8: 619.

Aumann, Robert J. (1996), Reply to Binmore, Games and Economic Behavior 17: 138146.

Aumann, Robert J. (1998), On the centipede game, Games and Economic Behavior 23: 97105.

Binmore, Ken (1987), Modeling rational players: part I, Economics and Philosophy 3: 955, reprinted in

Essays on the Foundations of Game Theory, by Ken Binmore, published by Basil Blackwell Inc., 1990.

Binmore, Ken (1996), A note on backward induction, Games and Economic Behavior 17: 135137.

Bliss, Christopher, and Barry Nalebu (1984), Dragon-slaying and ballroom dancing: the private supply of

a public good, Journal of Public Economics 25: 112.

Cornes, Richard, and Todd Sandler, The Theory of Externalities, Public Goods and Club Goods, 2nd ed.,

Cambridge University Press, 1996.

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Friedman, James W., Game Theory with Applications to Economics, 2nd ed., Oxford University Press,

1990.

Kreps, David M., A Course in Microeconomic Theory, Princeton University Press, 1990.

Kreps, David M., Paul Milgrom, John Roberts, and Robert Wilson (1982), Rational cooperation in the

nitely repeated prisoners dilemma, Journal of Economic Theory 27: 245252.

Lockwood, Ben, and Jonathan P. Thomas, Gradualism and irreversibility (2002), Review of Economic

Studies, 69: 339-356.

Marx, Leslie M., and Steven A. Matthews (2000), Dynamic voluntary contribution to a public project,

Review of Economic Studies 67: 327358.

McKelvey, Richard D., and Thomas R. Palfrey (1992), An experimental study of the centipede game,

Econometrica 60: 803836.

Megiddo, Nimrod (1986), Remarks on bounded rationality, IBM Research Report RJ 54310.

Neyman, Abraham (1985), Bounded complexity justies cooperation in the nitely repeated prisoners

dilemma, Economics Letters 19: 227229.

Palfrey, Thomas R., and Howard Rosenthal (1984), Participation and the provision of discrete public goods:

a strategic analysis, Journal of Public Economics 24:171193.

Pitchford, Rohan, and Christopher M. Snyder (2004), A solution to the hold-up problem involving gradual

investment, Journal of Economic Theory 114: 88103.

Radner, Roy (1980), Collusive behavior in noncooperative epsilon-equilibria of oligopolies with long but

nite lives, Journal of Economic Theory 22: 136154.

Rosenthal, Robert W. (1981), Games of perfect information, predatory pricing and the chain-store paradox,

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29

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