Cursed Equilibrium

Abstract

There is evidence that people do not fully take into account how other people’s actions are contingent on these others’ information. This paper defines and applies a new equilibrium concept in games with private information, "cursed equilibrium", which assumes that each player correctly predicts the distribution of other players’ actions, but underestimates the degree to which these actions are correlated with these other players’ information. We apply the concept to common-values auctions, where cursed equilibrium captures the widely observed phenomenon of the winner’s curse. We also show how cursed equilibrium predicts other empirically observed phenomena, such as trade in adverse- selection settings where conventional analysis predicts no trade, and "naïve" voting in elections and juries where rational-choice models predict that voters fully take into account the informational content in being pivotal.