Repeated Cooperation with Outside Options

Abstract

If agents can choose when to end a repeatable interaction as well as what to do within the partnership, cooperation incentives are interrelated with the ending decision. Using a Prisoner's Dilemma with outside options, we investigate how the structure of outside options affects the minimum discount factor that sustains mutual cooperation. One-sided outside options do not make cooperation easier than ordinary repeated games, but uncertainty of options reduces the difficulty by enabling cooperation until a good option realizes. Two-sided and very low outside options make cooperation easier than ordinary repeated games. Economic implications are also discussed.

Keywords: outside option, repeated Prisoner's Dilemma, cooperation

JEL Classification: C73