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Two-Armed Restless Bandits with Imperfect Information: Stochastic Control and Indexability

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  • Roland G. Fryer, Jr.
  • Philipp Harms

Abstract

We present a two-armed bandit model of decision making under uncertainty where the expected return to investing in the "risky arm'' increases when choosing that arm and decreases when choosing the "safe'' arm. These dynamics are natural in applications such as human capital development, job search, and occupational choice. Using new insights from stochastic control, along with a monotonicity condition on the payoff dynamics, we show that optimal strategies in our model are stopping rules that can be characterized by an index which formally coincides with Gittins' index. Our result implies the indexability of a new class of "restless'' bandit models.

Suggested Citation

  • Roland G. Fryer, Jr. & Philipp Harms, 2013. "Two-Armed Restless Bandits with Imperfect Information: Stochastic Control and Indexability," NBER Working Papers 19043, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:19043
    Note: IO LS
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    References listed on IDEAS

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    1. Will Dobbie & Roland G. Fryer Jr., 2013. "Getting beneath the Veil of Effective Schools: Evidence from New York City," American Economic Journal: Applied Economics, American Economic Association, vol. 5(4), pages 28-60, October.
    2. , & ,, 2010. "Strategic experimentation with Poisson bandits," Theoretical Economics, Econometric Society, vol. 5(2), May.
    3. Kohlmann, M., 1982. "Existence of optimal controls for a partially observed semimartingale," Stochastic Processes and their Applications, Elsevier, vol. 13(2), pages 215-226, August.
    4. Flavio Cunha & James J. HECKMAN, 2009. "Investing in our Young People," Rivista Internazionale di Scienze Sociali, Vita e Pensiero, Pubblicazioni dell'Universita' Cattolica del Sacro Cuore, vol. 117(3), pages 387-418.
    5. Nicolas Klein & Sven Rady, 2011. "Negatively Correlated Bandits," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 78(2), pages 693-732.
    6. Weitzman, Martin L, 1979. "Optimal Search for the Best Alternative," Econometrica, Econometric Society, vol. 47(3), pages 641-654, May.
    7. Godfrey Keller & Sven Rady & Martin Cripps, 2005. "Strategic Experimentation with Exponential Bandits," Econometrica, Econometric Society, vol. 73(1), pages 39-68, January.
    8. Ioannis Karatzas & Constantinos Kardaras, 2007. "The numéraire portfolio in semimartingale financial models," Finance and Stochastics, Springer, vol. 11(4), pages 447-493, October.
    9. Rothschild, Michael, 1974. "A two-armed bandit theory of market pricing," Journal of Economic Theory, Elsevier, vol. 9(2), pages 185-202, October.
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    Cited by:

    1. repec:hum:wpaper:sfb649dp2016-048 is not listed on IDEAS
    2. Vasama, Suvi, 2016. "Unraveling of cooperation in dynamic collaboration," SFB 649 Discussion Papers 2016-048, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.

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    More about this item

    JEL classification:

    • J0 - Labor and Demographic Economics - - General
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity
    • L0 - Industrial Organization - - General

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