A
strategy
of the agent B is a B-strategy, if, given that B follows , Ai?
Schwarz - Committments
There is an equilibrium where along the equilibrium
path the weak party occasionally reduces transfer level and the strong party immediately
takes action W; with subsequent resumption of transfers at the normal level. Note that ac-
tion W is not a punishment for a deviation, the victim was supposed to reduce the transfers
and the aggressor is supposed to i`punishi^this equilibrium behavior. The intuition for this
result is as following. According to Proposition 4 there exists a subgame perfect equilibrium
with transfers 9 y and there is an equilibrium with no transfers. It is easy to construct an 10
equilibrium where transfers are 1 y per period and once a year transfers by B are reduced to 2
zero for one month. At the end of that month A plays action W and B resumes transfers at rate 1y. If aggressor fails to take action W both players switch to playing the equilibrium
2
without transfers in the remaining subgame. If party B fails to reduce transfer to zero at the end of the year both parties play the equilibrium where transfers are 9 y in the remaining
10
subgame.
The model described above may shed some light on economics of terror. For decades,
the Irish Republican Army terrorizes the British government and people. A distinct feature of the IRA terror tactics is that acts of violence usually cause relatively small death toll, but, in retrospect, each attack might have caused much more human loss. The British making slow concessions and IRA engaging in occasional terrorist acts is consistent with an equilibrium path of play. Occasional bomb threats may be necessary to make the terroristsi? threat credible and thus induce more concessions from the British. Of course, there exists a more e? cient equilibrium where concessions are obtained without violence.
5 Conclusion
The bargaining game described herein captures some essential features of relationships were neither party has commitment power. A self-enforcing agreement is feasible if parties are either risk neutral or transfers do not change the balance of power. A successful peace agreement is likely to consists of a sequence of concessions. We show that if both parties are risk-averse and if transfers change balance of powers an ine? cient cona? ict may be inevitable.
The model of brinkmanship is our main contribution. We model brinkmanship as an ability to take an observable action that with large probability have no consequences and
? ? ? ? 18
with small probability ends the game with payo? s that are very undesirable for both sides. Examples of brinkmanship can be found situations ranging from international relations to Hollywood movies were gangster shoot under the feet to force a victim to cooperate. We show that if the action space of the potential aggressor allows him only two actions such as i? cooperatei? or i? go to the ultimate threat point,i? his bargaining power is far less than in a case where the potential aggressor can make probabilistic threats.
References
Acemoglu, Daron (2003) Why Not a Political Coase Theorem? Social Cona? ict, Commitment and Politics, Journal of Comparative Economics, Vol. 31, pp. 620n? 652.
Baliga, S. and Sjostrom, T. (2004) Arms Races and Negotiations, Review of Economic Studies, 71:2, 351-369.
Barzel, Y. (2002) A Theory of the State, Cambridge Univ. Press.
Becker, G. (1983) A Theory of Competition among Pressure Groups for Political Ina? uence, Quarterly Journal of Economics, 98, 371-400.
Besse, J. and Lasswell, H. (1950) Our Columnists on the A-Bomb, World Politics, 3:1, 72-87. Blainey, G. (1988) The Causes of War, 2d ed. New York: Free Press.
Broglie, Albert, duc de, (1879) The kingi? s secret: being the secret correspondence of Louis XV with his diplomatic agents, from 1752 to 1774. By the Duc de Broglie. London, New York [etc. ] Cassell, Petter & Galpin.
Carr, E. (1964) The Twenty Years Crisis, 1919-1939, New York: Harper and Row.
Coase, R. (1960) The Problem of Social Cost, Journal of Law and Economics, 1.
Coase, R. (1988) Blackmail, Virginia Law Review, 74: 4, 655-676.
Dixit, A. , Grossman, G. , and Gul, F. (2000) The Dynamics of Political Compromise, Journal of Political Economy, 108: 531-568.
Ginsburg, D. and Shechtman, P. (1993) Blackmail: An Economic Analysis of the Law, U. Penn Law Review, 141:1849-1876.
Fearon (1995) Rationalist Explanations for War, International Organization, 49 (3), 379-414. Filson, D. , and Werner, S. (2002) A Bargaining Model of War and Peace: Anticipating the Onset, Duration, and Outcome of War. American Journal of Political Science, 46, 819n? 38. Garnham, D. (1988) Power Parity and Lethal International Violence, 1969-1973, Journal of
19
Cona? ict Resolution, 20: 379-394.
Hensel, P. and Diehl, P. (1994) It Takes Two to Tango: Nonmilitarized Response in Interstate Disputes, Journal of Cona? ict Resolution, Vol. 38, No 3, 479-506.
Hirshleifer, J. (2001) Appeasement: Can it Work? American Economic Review Papers and Proceedings, v. 91, n. 2, 342-346.
Holsti, K. (1991) Peace and War: Armed Cona? icts and International Order, London: Rout- ledge.
Huth, P. (1988) Extended Deterrence and the Prevention of War, New Haven, CT: Yale University Press.
Laguno? , R. (2004) Dynamic Stability and Reform of Political Institutions, Georgetown University Manuscript
Leng, R. (1993) Interstate Crisis Behavior, 1816-1980: Realism versus Reciprocity, Cam- bridge: Cambridge University Press.
North, D. and Weingast, B. (1989) Constitutions and Commitment: The Evolution of In- stitutional Governing Public Choice in Seventeenth-Century England, Journal of Economic History.
Pillar, P. (1983) Negotiating Peace: War Termination as a Bargaining Process. Princeton: Princeton University Press.
Posner, R. (1993) Blackmail, Privacy, and Freedom of Contract, U. Penn Law Review, 141:1817-1843.
Powell, R. (2002) Bargaining Theory and International Cona? ict, Annual Review of Political Science, 5: 1-30.
Powell, R. (2004) War as a Commitment Problem, mimeo.
Powell, R. (1998) In the Shadow of Power: States and Strategies in International Politics, Princeton Univ. Press, Princeton, NJ.
Rajan, R. and Zingales, L (2000) The Tyranny of Ine? cient: An Enquiry into the Adverse Consequences of Power Struggles, Journal of Public Economics, Vol. 76, no. 3, 521-558. Schelling, T. (1966) Arms and Ina? uence. New Haven: Yale University Press.
Shavell, S. (1993) An Economic Analysis of Threats and Their Illegality: Blackmail, Extor- tion, and Robbery, U. Penn Law Review, 141:1877-1903.
Shavell, S. and Spier, K. (2002) Threats Without Binding Commitment, Topics in Economic Analysis and Policy, Vol. 2. Issue 1.
20
Shepsle, K. (1991). Discretion, Institutions and the Problem of Government Commitment in Bourdieu, Pierre and Coleman, James (eds) Social Theory for a Changing Society, Boulder: Westview Press.
Slantchev, B. (2001) Territory-Induced Credible Commitments in the European Concert System, 1815-54, mimeo.
Slantchev, B. (2003) The Power to Hurt: Costly Cona? ict with Completely Informed States, American Political Science Review, Vol. 47, No. 1. (March, 2003), pp. 123-135.
Slantchev, B. (2004) How Initiators End Their Wars: The Duration of Warfare and the Terms of Peace, American Journal of Political Science, 48:4. 813-829.
Smith, A. , and Stam, A. (2003) Bargaining and the Nature ofWar, mimeo.
Taylor, A. (1954) The Struggle for Mastery in Europe, 1848-1918, London: Oxford Univer- sity Press.
Taylor, A. (1961) The Origins of the World War Two, New York: Atheneum.
Wagner, H. (1982) Deterrence and Bargaining, Journal of Cona? ict Resolution, Vol. 2, No 6, 329-358.
Walzer, M. (1992) Just and Unjust Wars, 2d ed. , Basic Books.
Weede, E. (1976) Overwhelming Preponderance as a Pacifying Condition among Contiguous Asian Dyads, 1950-1969, Journal of Cona? ict Resolution, 20: 395-411.
Wilkenfeld, J. (1991) Trigger-response Transitions in Foreign Policy size, 1929-1988, Journal of Cona? ict Resolution, 35: 143-69.
Wittman, D. (2003) Credible Commitments and War: a Re-Evaluation, working paper, UCSC Economics Department
21
Appendix The setup
The set of players is N = fA;Bg: The set of histories is denoted H and ; 2 H. A vector function h, ht = (at; kt) belongs to the set of non-terminal histories if and only if the support ofhissomReinterval[0;T[;andforanyt2[0;T[wehaveat =Pandbt 0where bt = k0 + 0t ktdt: There is a natural interpretation of kt: we assumed that the function representing transfer proO? le is di? erentiable and thus continuous. Consequently, although player B can change the transfer level at any instant his choice must be consistent with continuity assumption, essentially, moment by moment player B chooses the derivative of transfer proO? le, which we denote kt: (We slightly abuse notation by denoting agenti? s choice of the level of transfer at time zero by k0. )
Let Z denote the set of all terminal histories. The set Z consists of two types of terminal histories: inO? nite (these where a cona? ict never occurs) and O? nite (these that end in a war). A vector function ht = (at;kt) belongs to the set of inO? nite histories if and only if h has support [0; +1[ and for all t; at = P and bt 0: A vector function ht = (at; kt) belongs to a set of O? nite terminal histories if and only if it has support [0; ], bt 0 and at = P for all t < ; and w( ) = W:
The choice correspondence P(h) = fA;Bg for all h 2 HnZ: In other words following any non terminal history both players take action simultaneously.
The preferences of players are given by the discounted sum of consumption utilities. The consumption proO? les and utilities corresponding to terminal nodes remain as deO? ned in Section 2.
Proofs
Proof of Proposition 1.
If R+1 U(x)g(xj0)dx U(0); then it is an eRquilibrium for B to send no transfers and 1 +1
for A not to start a war. On the other hand if 1 U(x)g(xj0)dx > U(0) playeri? s A best response is war if B chooses a strategy where transfers are zero. R +1
Starting a war is a strictly dominated action if and only if 1 U(x)g(xj0)dx < U(0). Consequently, if the inequality is strict player A will never choose to start a war and playeri? s B unique best response is to send no transfers: bt = 0:
22
DeO? nition.
A strategy of the agent B is a B-strategy, if, given that B follows , Ai? s pay-o? is the same regardless of the strategy A plays.
Proof of Proposition 2.
First, we prove that there exists a B-strategy. Let bt be a strategy of the player B: Starting a war at the moment (from the stand-point of today, which is t = 0 for simplicity), brings A the utility of
Z 1
V (bt;a =W)= U(bt)e tdt+ E[U(Xjb )]e :
0
The condition that Ai? s expected pay-o? from starting a war is the same at any means that dZ 1
d U(bt)e tdt+ E[U(Xjb )]e =0 0
? ? ? for all : Re-writing the above equation (and dropping e t), one gets U(b ) EU(Xjb )+1EdU(Xjb ) db =0: (1)
At =0;wehaveb0 deO? nedby
b0 = 1E[U(Xjb0)]: (2) There exists a unique solution to the above di? erential equation (1) satisfying the initial
condition (2).
Proof of Proposition 3. We need to consider the case of E[U(X)] > U(0): Consider the following strategy proO? le: suppose the strategy of player B calls for B-proO? le transfer schedule (see the proof of Proposition 2). To formally deO? ne a strategy of player B, assume that if at some decision node the history of the game is inconsistent with the B-proO? le then player B stops transferring resources to A forever. The strategy of A is to start a war, if B ever deviates from B-proO? le. Let us show that this strategy proO? le constitute a peaceful sub-game perfect equilibrium. By construction of B-proO? le, it is the best response for player A to start a war if B ever deviates and to abstain from a war as long as B follows this strategy. Now let us show that Bi? s strategy is a best response to Ai? s strategy. The di? erential equation governing the B-proO? le is
U(b ) E[U(Xjb )] = 0; 23
? ? ? db d
? since d E[U(Xjb )] = 0 by assumption. Therefore, b = b1 for all ; and dm
U(b1) = E[U(Xjb1)]:
Since A is risk-averse, b1 E[Xjb1]: The choice of player B is between deviating and receiving a consumption stream of x L thereafter, or receiving b1: In expectation, the former action brings the utility of 1 E[U( X Ljb1)]; while the latter brings 1 U( b1): Since b1 E[Xjb1];
E[U( X Ljb1)] < U( b1):
Thus, Bi? s best response is indeed to follow the B-proO? le transfer schedule.
Proof of Proposition 4. By inspection.
Proof of Example 1. By inspection. Suppose b(t) is a transfer proO? le that leaves A indif-
ferent between starting and not starting a war, we call this B-proO? le, among all appeasement
strategies this one gives the highest possible payo? to the weaker side. To show that peaceful
equilibrium does not exist we O? rst characterize B-proO? le and then show that even B-proO? le
gives the weaker side lower payo? than immediate war. To make the argument more in-
tuitive we start with comparing a payo? to party A from starting a war at time t versus
waiting till time t + . We take a limit of ! 0 and thus neglect terms of order o(): If
party A starts a war at time t its payo? is UA(b(t)+2) if a war is postponed till time t + 1
the payo? of party A becomes UA(b(t)) + UA(b(t+)+2) ; equating the payo? from starting 1
? ? ? ? ? a war at time t and t + we obtain the following di? erential equation describes B-proO? le: UA (b(t) + 2) UA (b(t)) = UA0 (b(t)+2)b0 (t) , Substituting UA = e c and solving the di? erential
? 1
equation we O? nd that transfers are linearly increasing in time b(t) = (exp(2) 1)(1 )t. It
is easy to check that this transfer proO? le gives utility of negative inO? nity to player B: Indeed, VB = R01 e(exp(2) 1)(1 )t t dt = 1 whenever (exp(2) 1)(1 ) + ln > 0. Thus, opting for a war gives player B a higher utility.
Proof of Proposition 5. To prove the existence, we construct a sub-game perfect equilib- rium as follows. First, we describe player Ai? s equilibrium strategy. If the victim, B transfers all resources so that her own instantaneous consumption is equal to b to the blackmailer, A; the latter makes no harm to B: If B transfers less than b (i. e. Bi? s instantaneous consumption is larger than x); A chooses at = W: With probability p a war erupts, and so the Ai? s pay-o? is y: With probability 1 p; the Ai? s pay-o? is b. Choosing at = P brings 0 in the future because the strategy of player B is to stop transfers if a deviation remains unpunished). So,
24
provided that (1 p)x py; it is proO? table for A to choose at = W: For A; not triggering a war while B transfers at rate b is clearly the best response. It is straightforward to fully specify strategies of both players o? the equilibrium path and to show that the equilibrium is subgame perfect because after an action W is taken players either O? nd themselves at a terminal node or in a subgame that is essentially identical to the original game.
path the weak party occasionally reduces transfer level and the strong party immediately
takes action W; with subsequent resumption of transfers at the normal level. Note that ac-
tion W is not a punishment for a deviation, the victim was supposed to reduce the transfers
and the aggressor is supposed to i`punishi^this equilibrium behavior. The intuition for this
result is as following. According to Proposition 4 there exists a subgame perfect equilibrium
with transfers 9 y and there is an equilibrium with no transfers. It is easy to construct an 10
equilibrium where transfers are 1 y per period and once a year transfers by B are reduced to 2
zero for one month. At the end of that month A plays action W and B resumes transfers at rate 1y. If aggressor fails to take action W both players switch to playing the equilibrium
2
without transfers in the remaining subgame. If party B fails to reduce transfer to zero at the end of the year both parties play the equilibrium where transfers are 9 y in the remaining
10
subgame.
The model described above may shed some light on economics of terror. For decades,
the Irish Republican Army terrorizes the British government and people. A distinct feature of the IRA terror tactics is that acts of violence usually cause relatively small death toll, but, in retrospect, each attack might have caused much more human loss. The British making slow concessions and IRA engaging in occasional terrorist acts is consistent with an equilibrium path of play. Occasional bomb threats may be necessary to make the terroristsi? threat credible and thus induce more concessions from the British. Of course, there exists a more e? cient equilibrium where concessions are obtained without violence.
5 Conclusion
The bargaining game described herein captures some essential features of relationships were neither party has commitment power. A self-enforcing agreement is feasible if parties are either risk neutral or transfers do not change the balance of power. A successful peace agreement is likely to consists of a sequence of concessions. We show that if both parties are risk-averse and if transfers change balance of powers an ine? cient cona? ict may be inevitable.
The model of brinkmanship is our main contribution. We model brinkmanship as an ability to take an observable action that with large probability have no consequences and
? ? ? ? 18
with small probability ends the game with payo? s that are very undesirable for both sides. Examples of brinkmanship can be found situations ranging from international relations to Hollywood movies were gangster shoot under the feet to force a victim to cooperate. We show that if the action space of the potential aggressor allows him only two actions such as i? cooperatei? or i? go to the ultimate threat point,i? his bargaining power is far less than in a case where the potential aggressor can make probabilistic threats.
References
Acemoglu, Daron (2003) Why Not a Political Coase Theorem? Social Cona? ict, Commitment and Politics, Journal of Comparative Economics, Vol. 31, pp. 620n? 652.
Baliga, S. and Sjostrom, T. (2004) Arms Races and Negotiations, Review of Economic Studies, 71:2, 351-369.
Barzel, Y. (2002) A Theory of the State, Cambridge Univ. Press.
Becker, G. (1983) A Theory of Competition among Pressure Groups for Political Ina? uence, Quarterly Journal of Economics, 98, 371-400.
Besse, J. and Lasswell, H. (1950) Our Columnists on the A-Bomb, World Politics, 3:1, 72-87. Blainey, G. (1988) The Causes of War, 2d ed. New York: Free Press.
Broglie, Albert, duc de, (1879) The kingi? s secret: being the secret correspondence of Louis XV with his diplomatic agents, from 1752 to 1774. By the Duc de Broglie. London, New York [etc. ] Cassell, Petter & Galpin.
Carr, E. (1964) The Twenty Years Crisis, 1919-1939, New York: Harper and Row.
Coase, R. (1960) The Problem of Social Cost, Journal of Law and Economics, 1.
Coase, R. (1988) Blackmail, Virginia Law Review, 74: 4, 655-676.
Dixit, A. , Grossman, G. , and Gul, F. (2000) The Dynamics of Political Compromise, Journal of Political Economy, 108: 531-568.
Ginsburg, D. and Shechtman, P. (1993) Blackmail: An Economic Analysis of the Law, U. Penn Law Review, 141:1849-1876.
Fearon (1995) Rationalist Explanations for War, International Organization, 49 (3), 379-414. Filson, D. , and Werner, S. (2002) A Bargaining Model of War and Peace: Anticipating the Onset, Duration, and Outcome of War. American Journal of Political Science, 46, 819n? 38. Garnham, D. (1988) Power Parity and Lethal International Violence, 1969-1973, Journal of
19
Cona? ict Resolution, 20: 379-394.
Hensel, P. and Diehl, P. (1994) It Takes Two to Tango: Nonmilitarized Response in Interstate Disputes, Journal of Cona? ict Resolution, Vol. 38, No 3, 479-506.
Hirshleifer, J. (2001) Appeasement: Can it Work? American Economic Review Papers and Proceedings, v. 91, n. 2, 342-346.
Holsti, K. (1991) Peace and War: Armed Cona? icts and International Order, London: Rout- ledge.
Huth, P. (1988) Extended Deterrence and the Prevention of War, New Haven, CT: Yale University Press.
Laguno? , R. (2004) Dynamic Stability and Reform of Political Institutions, Georgetown University Manuscript
Leng, R. (1993) Interstate Crisis Behavior, 1816-1980: Realism versus Reciprocity, Cam- bridge: Cambridge University Press.
North, D. and Weingast, B. (1989) Constitutions and Commitment: The Evolution of In- stitutional Governing Public Choice in Seventeenth-Century England, Journal of Economic History.
Pillar, P. (1983) Negotiating Peace: War Termination as a Bargaining Process. Princeton: Princeton University Press.
Posner, R. (1993) Blackmail, Privacy, and Freedom of Contract, U. Penn Law Review, 141:1817-1843.
Powell, R. (2002) Bargaining Theory and International Cona? ict, Annual Review of Political Science, 5: 1-30.
Powell, R. (2004) War as a Commitment Problem, mimeo.
Powell, R. (1998) In the Shadow of Power: States and Strategies in International Politics, Princeton Univ. Press, Princeton, NJ.
Rajan, R. and Zingales, L (2000) The Tyranny of Ine? cient: An Enquiry into the Adverse Consequences of Power Struggles, Journal of Public Economics, Vol. 76, no. 3, 521-558. Schelling, T. (1966) Arms and Ina? uence. New Haven: Yale University Press.
Shavell, S. (1993) An Economic Analysis of Threats and Their Illegality: Blackmail, Extor- tion, and Robbery, U. Penn Law Review, 141:1877-1903.
Shavell, S. and Spier, K. (2002) Threats Without Binding Commitment, Topics in Economic Analysis and Policy, Vol. 2. Issue 1.
20
Shepsle, K. (1991). Discretion, Institutions and the Problem of Government Commitment in Bourdieu, Pierre and Coleman, James (eds) Social Theory for a Changing Society, Boulder: Westview Press.
Slantchev, B. (2001) Territory-Induced Credible Commitments in the European Concert System, 1815-54, mimeo.
Slantchev, B. (2003) The Power to Hurt: Costly Cona? ict with Completely Informed States, American Political Science Review, Vol. 47, No. 1. (March, 2003), pp. 123-135.
Slantchev, B. (2004) How Initiators End Their Wars: The Duration of Warfare and the Terms of Peace, American Journal of Political Science, 48:4. 813-829.
Smith, A. , and Stam, A. (2003) Bargaining and the Nature ofWar, mimeo.
Taylor, A. (1954) The Struggle for Mastery in Europe, 1848-1918, London: Oxford Univer- sity Press.
Taylor, A. (1961) The Origins of the World War Two, New York: Atheneum.
Wagner, H. (1982) Deterrence and Bargaining, Journal of Cona? ict Resolution, Vol. 2, No 6, 329-358.
Walzer, M. (1992) Just and Unjust Wars, 2d ed. , Basic Books.
Weede, E. (1976) Overwhelming Preponderance as a Pacifying Condition among Contiguous Asian Dyads, 1950-1969, Journal of Cona? ict Resolution, 20: 395-411.
Wilkenfeld, J. (1991) Trigger-response Transitions in Foreign Policy size, 1929-1988, Journal of Cona? ict Resolution, 35: 143-69.
Wittman, D. (2003) Credible Commitments and War: a Re-Evaluation, working paper, UCSC Economics Department
21
Appendix The setup
The set of players is N = fA;Bg: The set of histories is denoted H and ; 2 H. A vector function h, ht = (at; kt) belongs to the set of non-terminal histories if and only if the support ofhissomReinterval[0;T[;andforanyt2[0;T[wehaveat =Pandbt 0where bt = k0 + 0t ktdt: There is a natural interpretation of kt: we assumed that the function representing transfer proO? le is di? erentiable and thus continuous. Consequently, although player B can change the transfer level at any instant his choice must be consistent with continuity assumption, essentially, moment by moment player B chooses the derivative of transfer proO? le, which we denote kt: (We slightly abuse notation by denoting agenti? s choice of the level of transfer at time zero by k0. )
Let Z denote the set of all terminal histories. The set Z consists of two types of terminal histories: inO? nite (these where a cona? ict never occurs) and O? nite (these that end in a war). A vector function ht = (at;kt) belongs to the set of inO? nite histories if and only if h has support [0; +1[ and for all t; at = P and bt 0: A vector function ht = (at; kt) belongs to a set of O? nite terminal histories if and only if it has support [0; ], bt 0 and at = P for all t < ; and w( ) = W:
The choice correspondence P(h) = fA;Bg for all h 2 HnZ: In other words following any non terminal history both players take action simultaneously.
The preferences of players are given by the discounted sum of consumption utilities. The consumption proO? les and utilities corresponding to terminal nodes remain as deO? ned in Section 2.
Proofs
Proof of Proposition 1.
If R+1 U(x)g(xj0)dx U(0); then it is an eRquilibrium for B to send no transfers and 1 +1
for A not to start a war. On the other hand if 1 U(x)g(xj0)dx > U(0) playeri? s A best response is war if B chooses a strategy where transfers are zero. R +1
Starting a war is a strictly dominated action if and only if 1 U(x)g(xj0)dx < U(0). Consequently, if the inequality is strict player A will never choose to start a war and playeri? s B unique best response is to send no transfers: bt = 0:
22
DeO? nition.
A strategy of the agent B is a B-strategy, if, given that B follows , Ai? s pay-o? is the same regardless of the strategy A plays.
Proof of Proposition 2.
First, we prove that there exists a B-strategy. Let bt be a strategy of the player B: Starting a war at the moment (from the stand-point of today, which is t = 0 for simplicity), brings A the utility of
Z 1
V (bt;a =W)= U(bt)e tdt+ E[U(Xjb )]e :
0
The condition that Ai? s expected pay-o? from starting a war is the same at any means that dZ 1
d U(bt)e tdt+ E[U(Xjb )]e =0 0
? ? ? for all : Re-writing the above equation (and dropping e t), one gets U(b ) EU(Xjb )+1EdU(Xjb ) db =0: (1)
At =0;wehaveb0 deO? nedby
b0 = 1E[U(Xjb0)]: (2) There exists a unique solution to the above di? erential equation (1) satisfying the initial
condition (2).
Proof of Proposition 3. We need to consider the case of E[U(X)] > U(0): Consider the following strategy proO? le: suppose the strategy of player B calls for B-proO? le transfer schedule (see the proof of Proposition 2). To formally deO? ne a strategy of player B, assume that if at some decision node the history of the game is inconsistent with the B-proO? le then player B stops transferring resources to A forever. The strategy of A is to start a war, if B ever deviates from B-proO? le. Let us show that this strategy proO? le constitute a peaceful sub-game perfect equilibrium. By construction of B-proO? le, it is the best response for player A to start a war if B ever deviates and to abstain from a war as long as B follows this strategy. Now let us show that Bi? s strategy is a best response to Ai? s strategy. The di? erential equation governing the B-proO? le is
U(b ) E[U(Xjb )] = 0; 23
? ? ? db d
? since d E[U(Xjb )] = 0 by assumption. Therefore, b = b1 for all ; and dm
U(b1) = E[U(Xjb1)]:
Since A is risk-averse, b1 E[Xjb1]: The choice of player B is between deviating and receiving a consumption stream of x L thereafter, or receiving b1: In expectation, the former action brings the utility of 1 E[U( X Ljb1)]; while the latter brings 1 U( b1): Since b1 E[Xjb1];
E[U( X Ljb1)] < U( b1):
Thus, Bi? s best response is indeed to follow the B-proO? le transfer schedule.
Proof of Proposition 4. By inspection.
Proof of Example 1. By inspection. Suppose b(t) is a transfer proO? le that leaves A indif-
ferent between starting and not starting a war, we call this B-proO? le, among all appeasement
strategies this one gives the highest possible payo? to the weaker side. To show that peaceful
equilibrium does not exist we O? rst characterize B-proO? le and then show that even B-proO? le
gives the weaker side lower payo? than immediate war. To make the argument more in-
tuitive we start with comparing a payo? to party A from starting a war at time t versus
waiting till time t + . We take a limit of ! 0 and thus neglect terms of order o(): If
party A starts a war at time t its payo? is UA(b(t)+2) if a war is postponed till time t + 1
the payo? of party A becomes UA(b(t)) + UA(b(t+)+2) ; equating the payo? from starting 1
? ? ? ? ? a war at time t and t + we obtain the following di? erential equation describes B-proO? le: UA (b(t) + 2) UA (b(t)) = UA0 (b(t)+2)b0 (t) , Substituting UA = e c and solving the di? erential
? 1
equation we O? nd that transfers are linearly increasing in time b(t) = (exp(2) 1)(1 )t. It
is easy to check that this transfer proO? le gives utility of negative inO? nity to player B: Indeed, VB = R01 e(exp(2) 1)(1 )t t dt = 1 whenever (exp(2) 1)(1 ) + ln > 0. Thus, opting for a war gives player B a higher utility.
Proof of Proposition 5. To prove the existence, we construct a sub-game perfect equilib- rium as follows. First, we describe player Ai? s equilibrium strategy. If the victim, B transfers all resources so that her own instantaneous consumption is equal to b to the blackmailer, A; the latter makes no harm to B: If B transfers less than b (i. e. Bi? s instantaneous consumption is larger than x); A chooses at = W: With probability p a war erupts, and so the Ai? s pay-o? is y: With probability 1 p; the Ai? s pay-o? is b. Choosing at = P brings 0 in the future because the strategy of player B is to stop transfers if a deviation remains unpunished). So,
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provided that (1 p)x py; it is proO? table for A to choose at = W: For A; not triggering a war while B transfers at rate b is clearly the best response. It is straightforward to fully specify strategies of both players o? the equilibrium path and to show that the equilibrium is subgame perfect because after an action W is taken players either O? nd themselves at a terminal node or in a subgame that is essentially identical to the original game.
