The evolution of a global network: a game of coalition formation

The paper explores the evolution of global networks. Examples include networks which process cross-border securities trades: CEDEL, Euroclear, and FITEL. I formalize a network market with many users: due to fixed costs the supply is downward slopping, and due to externalities the demand is upward slopping. Using game theory and dynamic stochastic analysis I show how the network evolves. I introduce the concept of critical mass, define a stochastic process of coalition formation, and specify the long run properties of the resulting network markets, including dynamics and stability properties, and the number of stable configurations. I explain the formation of coalitions of users when the players are heterogeneous: there exist clusters of players which produce more externalities to each other that they do the rest: e.g. global custodians. The gains from distinguishing such clusters are surprisingly large: the probability of success of the network "star-up" increases exponentially with decreases in the cluster size.