State of the art of research on higher order beliefs: theory and experiments.

I will present theoretical advances and experimental evidence about the concept "higher order beliefs," i.e., players' beliefs about other players beliefs, players' beliefs about other players' beliefs about other players' beliefs, and so on. The core game demonstrating the relationship between theory and bounded rational behavior is the beauty contest game, spanning a rich set of class of games in micro and macroeconomics of expectation formation. The corresponding bounded rational model explaining experimental data is the socalled level k model or cognitive hierarchy models. While game theoretic reasoning often leads to unique or few possible solutions (based on common knowledge of rationality), experimental evidence presents heterogeneous behavior given random behavior, cognitive constraints, or beliefs of constraints of other agents. Simple best reply reactions without higher order beliefs might be the predominant outcome in most of the situations. This is in particular true when faced with limited information about the environment or other agents’ behavior and behavior over time, resulting in simple adaptive behavior. Theoretical advances, incooperating such results, have been made in particular in microeconomic theory but also recently in macroeconomic theory. There are also some initial field studies that demonstrate this kind of bounded rational reasoning.