Coalitional Stability under Perfect Foresight

We analyze strategic social environments where coalitions can form through binding or nonbinding agreements and actions of a coalition may impose externalities upon the welfare of the rest of the players. We define a solution concept that (1) captures the perfect foresight of the players that has been overlooked in the literature (e.g., Harsanyi [10] and Chwe [6]) and (2) identifies the coalitions that are likely to form and the “stable” outcomes that will not be replaced by any coalition of rational (and hence farsighted) players. The proposed solution concept thereby offers a notion of agreements and coalition formation in complex social environments. Journal of Economic Literature Classification Numbers: C70, C71, C72. †Mailing address: Department of Economics, McGill University, 855 Sherbrooke St. West, Montreal, Quebec, Canada H3A 2T7; e-mail: [email protected]. This paper is based on the second chapter of my Ph.D. dissertation at McGill University. I am grateful to Joseph Greenberg, my dissertation supervisor, for his encouragement and guidance, and to Geir Asheim, Venki Bala, Michael Chwe, Faye Diamantoudi, Rob Gilles, Xiao Luo, Dov Monderer, Benyamin Shitovitz, Vicky Zinde-Walsh, and two anonymous referees for helpful comments. The remarks of the participants of “Summer in Tel Aviv Economic Theory Workshop 1996” urged me to motivate coalitional analysis at a more fundamental level. Financial support from the Social Sciences and Humanities Research Council of Canada (SSHRC) through a doctoral fellowship and from Fonds FCAR, Quebec, is gratefully acknowledged.