Endogenous neighborhood formation in a local coordination model with negative network externalities

The paper studies the evolution of coordination in a local interaction model where agents can simultaneously choose the strategy to play in the game and the size of their neighborhood. We focus on pure-coordination games played by agents located on one-dimensional lattices and we assume that network externalities become eventually negative as neighborhood sizes increase. We show that the society almost always converges to a steady-state characterized by high levels of coordination and small neighborhood sizes. We find that neighborhood adjustment allows for higher coordination than if interaction structures were static and that large populations attain higher coordination provided that average initial neighborhood sizes are not too small. (C) 2004 Elsevier B.V. All rights reserved.