Saturday, February 14, 2009

Hawk-Dove Model for Economic Recovery

It may appear to be a good time to buy anything as prices have hit all time lows, but most investors are cautious and are probably expecting a bit more downside before getting into the market. However, this unique scenario is very similar to a Hawk-Dove model in game theory (or more commonly known as a game of "Chicken").

The longer investors can hold out, the more they will potentially benefit from declining prices. Investors who decide to make an early entrance now will become "Doves" whereas those who can hold out a bit longer will be "Hawks". The scenario where everyone holds out forever the result will be a "crash".

Although much more complicated than the simple 2x2 matrix traditionally associated to this model, the fundamental theories at play are very similar. Also, funds, investors and individual "players" are capable of signaling their intentions to the market (although not-binding) through leading economic indicators and the movement of capital.

Having said that, there is an anticipated equilibrium point at which players can be expected to make an entrance back into the market (although it can't be simply computed as a Nash Equilibrium as there are no simple hard numbers). However, for those who are doing model based trading or risk analysis and are able to pick out the appropriate indicators can use this interesting perspective as a component to build into their analysis for a time horizon of one to two years.

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