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Trading Favors: Optimal Exchange and Forgiveness

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  • Christine Hauser
  • Hugo Hopenhayn

Abstract

How is cooperation without immediate reciprocity sustained in a long term relationship? We study the case of two players in continuous time who have privately observable opportunities to provide favors, and where the arrival of these opportunities is a Poisson process. Favors provided by a player give her an entitlement to future favors from her partner. As opposed to a "chips mechanism" where the rate of exchange of favors is one, we allow for two features: first, for the rate of exchange to depend on current entitlements, and second, for the possibility of depreciation or appreciation of entitlements. We show that these two features allow for considerably higher payoffs. We characterize and solve for the Pareto frontier of Public Perfect Equilibria (PPE) and show that it is self-generating. This guarantees that the equilibrium is renegotiation proof. We also find that optimal PPE have two key characteristics: 1) the relative price of favors decreases with a player's entitlement and 2) the disadvantaged player's utility increases over time during periods of no trade, so in the optimal equilibria there is forgiveness.

Suggested Citation

  • Christine Hauser & Hugo Hopenhayn, 2008. "Trading Favors: Optimal Exchange and Forgiveness," Carlo Alberto Notebooks 88, Collegio Carlo Alberto.
  • Handle: RePEc:cca:wpaper:88
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    File URL: http://www.carloalberto.org/assets/working-papers/no.88.pdf
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    Cited by:

    1. Thomas Wiseman, 2015. "A Note on the Essentiality of Money under Limited Memory," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(4), pages 881-893, October.
    2. repec:the:publsh:2771 is not listed on IDEAS
    3. Arina Nikandrova & Jevgenijs Steinbuks, 2017. "Contracting for the second best in dysfunctional electricity markets," Journal of Regulatory Economics, Springer, vol. 51(1), pages 41-71, February.
    4. repec:the:publsh:2434 is not listed on IDEAS
    5. Compte, Olivier & Postlewaite, Andrew, 2015. "Plausible cooperation," Games and Economic Behavior, Elsevier, vol. 91(C), pages 45-59.
    6. Josef Schroth, 2013. "Fiscal policy coordination in monetary unions," 2013 Meeting Papers 74, Society for Economic Dynamics.

    More about this item

    Keywords

    repeated games; jump process; continuous time;

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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