Title: Nash Bargaining with Endogenous Outside Options.
Abstract: Outside options shape bargaining outcomes, but understanding how they are determined is often challenging, because one's outside options depend on others' outside options, which depend, in turn, on others' outside options, and so on. In this paper, I describe a non-cooperative theory of coalition formation that shows how the classical Nash bargaining solution uniquely pins down both the sharing rule and the relevant outside options in each coalition. This provides a tractable framework to investigate how different economic shocks propagate via outside options. In pairwise matching environments where agents are vertically differentiated by their skills, shocks propagate from the high to the low skill, but not vice versa. Positive assortative matching necessarily arises if and only if skills are complementary. In this case, shocks propagate in blocks, in the sense that when a shock propagates from one agent to another one, it also propagates to everyone whose skill is in between.
Draft Date: November 19, 2018.
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