FEEM working papers "Note di lavoro" series
2004 .078

Contracting with Externalities and Outside Options

Authors: Francis Bloch, Armando Gomes
Series: Climate Change and Sustainable Development
Editor: Carlo Carraro
Type: Journal
Keywords: Outside options,Externalities,Coalitional bargaining
JEL n.: C71,C72,C78,D62
JEL: Journal of Economic Theory,
Pages: Vol. 127, Issue 1, pp. 172-201
Date: 03/2006


This paper proposes a model of multilateral contracting where players are engaged in two parallel interactions: they dynamically form coalitions and play a repeated normal form game with temporary and permanent decisions. This formulation encompasses many economic models with externalities and outside options. We show that when outside options are pure (i.e. independent of the actions of other players), there exists a Markov Perfect equilibrium resulting in efficient outcomes when players become perfectly patient. If outside options are not pure, all Markov perfect equilibria may be inefficient. The distribution of coalitional gains and the dynamics of coalition formation are characterized in four illustrative applications.

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