Dynamics and stability in network formation games with bilateral contracts

We consider a network formation game where a finite number of nodes wish to send traffic to each other. Nodes contract bilaterally with each other to form communication links; once the network is formed, traffic is routed along shortest paths (if possible). Cost is incurred to a node from four sources: (1) routing traffic; (2) maintaining links to other nodes; (3) disconnection from destinations the node wishes to reach; and (4) payments made to other nodes. We assume that a network is stable if no single node wishes to unilaterally deviate, and no pair of nodes can profitably deviate together. We characterize stable networks, and study the efficiency of those networks. We also consider myopic best response dynamics in the case where links are bidirectional. Under certain assumptions, these myopic dynamics converge to a stable network; further, they naturally select an efficient equilibrium out of the set of possible equilibria.