Structural holes in social networks

We consider a setting where every pair of players that undertake a transaction (e.g. exchange goods or information) create a unit surplus. A transaction can take place only if the players involved have a connection. If the connection is direct the two players split the surplus equally while if it is indirect then intermediate players also get an equal share of the surplus. Thus individuals form links with others to create surplus, to gain intermediation rents and to circumvent others who are trying to become intermediary. Our analysis clari…es the interplay between these forces in the process of strategic network formation. First, we show that, in the absence of capacity constraints on links, it leads to the emergence of a star network where a single agent acts as an intermediary for all transactions and enjoys signi…cantly higher payo¤s. Second, we study the implications of capacity constraints in the ability of agents to form links. In this case, distances between players must be long, which induces players who are “far o¤” to connect in order to avoid paying large intermediation rents. A cycle network then emerges, payo¤s being equal across all players. Department of Economics, University of Essex, [email protected]. yDepartment of Economics, Universidad de Alicante, University of Essex, and Instituto Valenciano de Investigaciones Económicas, [email protected]. We have bene…tted from comments of an associate editor and two anonymous referees. We have also bene…tted from the comments of Coralio Ballester, Andrea Galeotti, Suresh Mutuswami, Arno Riedl, and seminar audiences at Brown, Cornell, Northwestern, Madison, Warwick, Stockholm, Oxford, and Barcelona.