Recent theories from complexity science argue that complex dynamics are ubiquitous in social and economic systems. These claims emerge from the analysis of individually simple agents whose collective behavior is surprisingly complicated. However, economists have argued that iterated reasoning–what you think I think you think–will suppress complex dynamics by stabilizing or accelerating convergence to Nash equilibrium. We report stable and efficient periodic behavior in human groups playing the Mod Game, a multi-player game similar to Rock-Paper-Scissors. The game rewards subjects for thinking exactly one step ahead of others in their group. Groups that play this game exhibit cycles that are inconsistent with any fixed-point solution concept. These cycles are driven by a “hopping” behavior that is consistent with other accounts of iterated reasoning: agents are constrained to about two steps of iterated reasoning and learn an additional one-half step with each session. If higher-order reasoning can be complicit in complex emergent dynamics, then cyclic and chaotic patterns may be endogenous features of real-world social and economic systems.
Frey S, Goldstone RL (2013) Cyclic Game Dynamics Driven by Iterated Reasoning. PLoS ONE 8(2): e56416. http://dx.doi.org/10.1371/journal.pone.0056416
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This paper provides additional evidence that financial risk management can benefit by incorporating more insights from the area of complex systems into various aspects of risk modeling and control.