A Simple Game Theoretic Analysis of Peering and Transit Contracting among Internet Access Providers

The paper presents a simple game theoretic model of two Internet access providers who choose between peering and transit agreements. There is no regulation with regard to interconnection policies of providers, though there is a general convention that the providers peer if they perceive equal benefits from peering, and have transit arrangements otherwise. In the literature there is a debate whether the large providers gain and exploit market power through the terms of interconnection that they offer to smaller providers. In this paper we develop a game theoretic model to examine how providers decide who they want to peer with and who has to pay transit. The model discusses a set of conditions, which determine the formation of peering and transit agreements. The model takes into account the costs of carrying traffic by peering partners. Those costs should be roughly equal for the providers to have incentives to peer, otherwise the larger provider believes that the smaller provider might free ride on its infrastructure investments. The analysis suggests that the providers do not necessarily exploit market power when refusing to peer. Moreover, Pareto optimum is achieved under transit arrangements only. The paper argues that the market forces determine the decisions of peering and transit, and there is no need for regulation to encourage peering. Furthermore, to increase efficiency, the regulators might actually need to promote transit arrangements.