Terrorism and signalling

Abstract

This paper presents an analysis of terrorism based on a signalling game in which an uninformed government uses the first-period attacks of the (informed) terrorist to assess terrorists' capabilities. Based on posterior beliefs, the government decides in period 2 whether to resist or to capitulate. A perfect Bayesian equilibrium for the two-period signalling game is derived in which the government prefers the associated partial-pooling equilibrium over the never-surrender equilibrium. This pooling equilibrium is associated with probabilistic regret owing to ex post wrong inferences. Intelligence is valued, because it can limit this regret if it can reduce the variance of government priors.