Refundable Deposits: How to Restore Cooperation in Finitely Repeated Games

Abstract

While infinitely repeated games admit a rich set of Nash equilibria, finitely repeated games typically have a much smaller and often inefficient one. We show how to enlarge this set using deposits: in each period a player may place a refundable sum with a neutral intermediary, returned when the game ends and forfeited following a deviation. Paying these deposits is voluntary and incentive compatible at every stage, so no commitment by the players is assumed, the only commitment required being that of the intermediary to a refund rule fixed before play begins. The mechanism sustains payoff profiles more efficient than those of the standard equilibria, without altering the underlying game and without transfers between players. We demonstrate it on the prisoner's dilemma, a congestion game, and a public goods game, all settings where cooperation cannot emerge in the standard finitely repeated version. We also apply it to a dynamic common-pool resource, suggesting that the construction extends beyond repeated stage-games.