Co-author: Friederike Mengel, University of Nottingham

Social Interactions frequently display two pervasive phenomena: agents tend to interact with similar others (homophily), and tend to treat others more favorably if they are perceived to share their same identity (in-group bias). While both phenomena involve some degree of discrimination towards others, a systematic study of their relations and interplay is yet missing. In this paper we address this issue in the context of an experiment in which agents are exogenously and randomly assigned to one of two groups. Subsequently they play a sequence of eight games with either an in-group or an out-group member. We find strong evidence of in-group bias when agents are matched exogenously. When agents can affect who they are matched with endogenously, they prefer to be matched within their group. There is clear evidence of homophily. However, with homophily at work we find that in-group biases either decrease or disappear alltogether. This is due both to the self selection of homophilous agents into in-group matches to a change in behavior. We also show that homophily is strongly correlated with risk aversion, and we use this fact to provide an explanation for both the existence of homophily and the disappearance of in-group biases under endogenous matching.