Noisy signaling: Theory and experiment

We introduce noise in the signaling technology of an otherwise standard wasteful signaling model (Spence, 1973). We theoretically derive the properties of the equilibria under different levels of noise and we experimentally test how behavior changes with noise. We obtain three main insights. First, if the amount of noise increases, high types aiming for separation (must) increase their signaling expenditures. This theoretical prediction is confirmed in our experiment. Second, for intermediate and high levels of noise, a separating and pooling equilibrium co-exist. In the experiment, subjects tend to shift from coordinating on a separating outcome to a pooling one as noise increases. Third, a surprising theoretical insight is that a separating equilibrium ceases to exist for low levels of noise (and an unfavorable prior). Yet in the experiment subjects then do coordinate on separation. A simple attraction learning model incorporating belief learning, imitation and reinforcement, explains this stable non-equilibrium behavior.