Strategic Experimentation with Heterogeneous Agents and Payoff Externalities

In this paper, I examine the effect of introducing heterogeneity between players in models of strategic experimentation. I consider a two-armed bandit problem with one safe arm and a risky arm. There are two players and each has an access to such a bandit. A player using the safe arm experiences a safe flow payoff . The risky arm can either be good or bad. A bad risky arm is worse than the safe arm and the good risky arm is better than the safe arm. Players start with a common prior about the probability of the risky arm being good. We show that without any payoff externalities, heterogeneous players in non cooperative equilibrium do more experimentation than a model with homogeneous players. When competition is introduced between the players, inefficiency in non cooperative equilibrium is in form of too much of experimentation along the risky arm. JEL Classification Numbers:C73, D83, O31.