Bidding and sequential coalition formation with externalities

We study a coalition formation game with externalities where each agent’s payoff depends on the entire partition (see, e.g., Bloch (1996)). As in Bloch (1996) and Ray and Vohra (1999), we assume that coalitions form sequentially and once a coalition forms, it cannot dissolve nor can its members forge new coalitions with the rest of the agents. However, instead of an exogenously given protocol, we use a “bidding mechanism” (see, e.g., Pérez-Castrillo and Wettstein (2002)) to endogenously determine proposers. This mechanism also generates transfers among the agents. We show that such a mechanism facilitates the attainment of efficiency; in particular, a dynamically efficient Markov perfect equilibrium always exists. Nevertheless, there are games that also admit inefficient equilibria.