The Expected Externality Mechanism in a Level-k Environment

Mechanism design theory strongly relies on the concept of Nash equilibrium. However, studies of experimental games show that Nash equilibria are rarely played and that subjects may be thinking only a finite number of iterations. We study one of the most influential benchmarks of mechanism design theory, the expected externality mechanism (D’Aspremont, Gerard-Varet, 1979) in a finite-depth environment described by the Lk model. While efficient implementation fails under certain conditions, our results provide a vindication of the mechanism in the convex quasi-linear environment with finitely-rational agents.