Journal Article

A Theory of Endogenous Commitment

Guillermo Caruana and Liran Einav

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 75, issue 1, pages 99-116
Published in print January 2008 | ISSN: 0034-6527
Published online January 2008 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2007.00470.x
A Theory of Endogenous Commitment

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Commitment is typically modelled by assigning to one of the players the ability to take an initial binding action. The weakness of this approach is that the fundamental question of who has the opportunity to commit cannot be addressed, as it is assumed. This paper presents a framework in which commitment power arises endogenously from the fundamentals of the model. We construct a finite dynamic game in which players are given the option to change their minds as often as they wish, but pay a switching cost if they do so. We show that for games with two players and two actions there is a unique subgame-perfect equilibrium with a simple structure. This equilibrium is independent of the order and timing of moves and is robust to other protocol specifications. Moreover, despite the perfect information nature of the model and the costly switches, strategic delays may arise in equilibrium. The flexibility of the model allows us to apply it to various environments. In particular, we study an entry deterrence situation. Its equilibrium is intuitive and illustrative of how commitment power is endogenously determined.

Keywords: C73

Journal Article.  12056 words.  Illustrated.

Subjects: Game Theory and Bargaining Theory

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