Game Theory
Game Theory is a theoretical framework for evaluating and analysing social situations among competing players. Game theory can be used in real-world scenarios and their outcomes can be predicted. The central piece of the theory is the game, which acts like the model. And there exist players with different value vectors that are dependent on the actions of other players. The actions of other players can be classified and boiled down to strategies.
Within finance, a phenomenon that was noted early on with IPO’s that some stocks had a significantly positive run. Game theory provided an explanation that there existed two groups, one that knew the true value of the stock and the others that were still uninformed. The group that knew the true value would only buy it when it was at or below the true value. While the uninformed group would then be left with overpriced blocks. Game-theoretic models have been used to explain different aspects of finance. However, with more information and data being available behavioural models are being used to explain what game theory couldn’t. This can be due to the face that game theory assumes a certain degree of rationality from the players, while that might not be true in the real-world.
Related