Network Formation with Heterogeneous Agents and Absolute Friction

Abstract

We present a model of strategic network formation with absolute friction and heterogeneous agents. The individual payoffs from a given network are determined by the difference of an agent specific utility function that depends on the number of her direct links and the sum of her link-costs. These link-costs decompose in a symmetric function that represents the social distance between the two agents and an agent specific function representing the partner’s quality. From a theoretical point of view, we analyze strong pairwise stable networks (Belleflamme and Bloch, Int Econ Rev 45(2):387–411, 2004) and show that our model always has a unique strong pairwise stable network which is also strongly stable (Dutta and Mutuswami, J Econ Theory, 76:322–344, 1997). From a practical point of view, we provide an algorithm that reproduces this stable network from information on the individual payoff structure. We illustrate the use of this algorithm by applying it to an informal risk sharing network data set from the village of Nyakatoke in rural Tanzania.