Friday, June 26, 2009

Game Theory - An "Emerging" Field of Study and Interest

While game theory, the study of strategic interactions, has been a field of study in social psychology for sometime, it has become an increasingly important field which on which management science has recently begun to focus on. Particularly, the logical analysis of decision making processes to optimize success as defined within the model.

While the CFA has introduced the idea in the Economics portion of their level I curriculum, I thought that it would be valuable to look beyond what is presented there (including the "optional" sections) and how using game theory can predict strategic level behaviours.

First, the basics, we are familiar with the Hawk-Dove model (a game of chicken) which I used in my investment blog to describe the benefits and pitfalls awaiting investors hoping to gain first movers advantage in the market. I've also used the Prisoner's Dilemma to describe OPEC and Oil.

However, what is what oversimplifies these two examples of game theory is the assumption that they occur only once. That is to say that these models only look at a particular snapshot in time. Whereas we know that the game continues to be played and is modeled by a series of events rather than one discrete iteration. Also, the models used to describe these scenarios are simple 2x2 matrices. As we start to remove some of the assumptions, we will also begin to look at more flexible (and therefore complex) models.

In the next couple of posts and into next week, I will focus on a series of posts aiming to look at more involved cases of game theory and how they can be used to model strategic business behaviour.

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