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Can Endogenous Group Formation Prevent Coordination Failure? A Theoretical and Experimental Investigation

Listed author(s):
  • Raab, Philippe


    (Allianz Insurance Group)

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    This paper studies the effect of endogenous group formation on the outcome in two types of coordination games with multiple Pareto-ranked equilibria. Endogenous group formation means that in each period players are free to choose among two or more groups within which they want to play the coordination game. In the theoretical part we show that a simple myopic best reply dynamics under endogenous group formation leads to the payoff dominant outcome in both types of coordination games, independently of the initial strategy profile. In the experimental part we test this prediction. Our results show that the accuracy of the theoretical prediction is sensitive to the out-of-equilibrium properties of the respective coordination game. If the collective outcome is very sensitive to unilateral deviations, the coordination failure takes the same form under endogenous group formation as in the case of fixed groups. If, however, the coordination game is sufficiently robust against these unilateral deviations, coordination on the payoff dominant equilibrium is observed for the large majority of subjects under endogenous group formation. Moreover, in the former case we find the emergence of equally sized groups, while in the latter case large groups emerge. Interestingly, the respective group sizes can be interpreted as minimizing the individual's risk of encountering coordination deteriorating players.

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    Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 1628.

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    Length: 34 pages
    Date of creation: Jun 2005
    Handle: RePEc:iza:izadps:dp1628
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    1. Noldeke, Georg & Samuelson, Larry, 1997. "A Dynamic Model of Equilibrium Selection in Signaling Markets," Journal of Economic Theory, Elsevier, vol. 73(1), pages 118-156, March.
    2. John B. Van Huyck & Raymond C. Battalio & Richard O. Beil, 1991. "Strategic Uncertainty, Equilibrium Selection, and Coordination Failure in Average Opinion Games," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 885-910.
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