Game Theory and Behavioral Finance Gregory LaBlanc September 11th, 2014 R e v o l u t i o n i z i n g G l o b a l L e a d e r s h i p 1
Bubbles Game Theory and Behavioral Finance 2
Tulipmania Game Theory and Behavioral Finance 3
South Sea Bubble 4 Game Theory and Behavioral Finance
Japanese Real Estate ● 1991, land value in Japan nearly $20 trillion. Over 20% of world’s wealth Double world’s equity markets ● Land under Emperor’s Palace (3/4 sq mi) estimated to be worth same as all land in California or in Canada = Game Theory and Behavioral Finance 5
Index of Tokyo Area Commercial Land Values 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 6 8 0 2 4 6 8 0 2 4 8 8 9 9 9 9 9 0 0 0 9 9 9 9 9 9 9 0 0 0 1 1 1 1 1 1 1 2 2 2 Year Source: “Urban Land Price Index and National Wooden House Market Value Index as of the End of March 2004,” Japan Real Estate Institute, May 2004. Game Theory and Behavioral Finance 6
VA Linux ● Dec 1999 IPO open @ $30; traded as high $320; closed $239 179 employees $9.5 billion market cap (~53 million per employee) Game Theory and Behavioral Finance 7
Game Theory and Behavioral Finance 8
Webvan Game Theory and Behavioral Finance 9
Pets.com Game Theory and Behavioral Finance 10
Housing in the 2000s 11 Game Theory and Behavioral Finance
Housing in the 2000s 12 Game Theory and Behavioral Finance
13 Game Theory and Behavioral Finance
Zynga Game Theory and Behavioral Finance 14
Experimental Economics Game Theory and Behavioral Finance 15
Overview of the Experimental Environment ● Caginalp, Porter, and Smith (2001) ● Features of the Experimental setup 15 period asset Dividend uncertainty • {0,8,28,60} Initial cash and shares Double auction or call market trading mechanism Experiment is repeated with same traders Game Theory and Behavioral Finance 16
Fundamental Value Line 450 Fundamental Value 400 350 300 Price in Cents 250 200 150 100 50 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Period Courtesy of David Porter Game Theory and Behavioral Finance
The Computer Interface Game Theory and Behavioral Finance 18
Inexperienced Traders’ Time Series Fundamental Value 450 Inexperienced Once-Experienced 400 Twice-Experienced 350 2 13 3 9 4 3 3 8 3 1 7 300 3 Price in Cents 4 8 8 5 250 6 1 2 7 2 6 200 5 8 11 6 150 1 5 4 12 100 1 2 9 7 1 1 6 2 1 50 4 2 1 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 19 Period Courtesy of David Porter Game Theory and Behavioral Finance
Experience Deviation from Fundamental Value Deviation from Fundamental Value 300 300 Deviation from Fundamental Value 300 200 200 200 100 100 Price - FV 100 Price - FV Price - FV 0 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 -100 -100 -100 -200 -200 -200 -300 -300 -300 -400 Inexperienced Inexperienced -400 Period -400 Inexperienced Once Experienced Period Period Once Experienced 20 Tw ice Experienced Game Theory and Behavioral Finance
Game Theory ● Simple games involve Two players Two “strategies” ● Create a two by two payoff matrix ● Classic games Prisoners Dilemma (public goods) game Stag and Hare (assurance, pure cooperation)game Hawk and Dove (conflict) game Game Theory and Behavioral Finance 21
Hunting Stag Game Theory and Behavioral Finance 22
Hunting Hare Game Theory and Behavioral Finance 23
Stag and Hare 4 2 4 0 0 2 2 2 Game Theory and Behavioral Finance 24
Stag and Hare Average Average Payoff Payoff 4 Payoff to stag 2 Payoff to hare 2 0 Percentage who chose stag 100 Game Theory and Behavioral Finance 25
Standard Wars Game Theory and Behavioral Finance 26
Path Dependence Game Theory and Behavioral Finance 27
Hawk or Dove? Game Theory and Behavioral Finance 28
If V<W, which is best? Hawk Dove Hawk ½ (V-W) 0 ½ (V-W) V Dove V ½ V 0 ½ V Game Theory and Behavioral Finance 29
If V<W direction of evolution V ½ V payoff to hawks payoff to doves 0 100 % 0%Percentage of bird population hawks ½(V-W) Game Theory and Behavioral Finance 30
Frequency Dependent Strategies Game Theory and Behavioral Finance 31
MixedStrategies Game Theory and Behavioral Finance 32
Game Theory and Behavioral Finance 33
Randomizer Game Theory and Behavioral Finance 34
Game Theory and Behavioral Finance 35
Game Theory and Behavioral Finance 36
Game Theory and Behavioral Finance 37
Too many fastballs Game Theory and Behavioral Finance 38
Too much alternating! Game Theory and Behavioral Finance 39
Not enough passing Game Theory and Behavioral Finance 40
Too much alternating Game Theory and Behavioral Finance 41
Which Route to take? Game Theory and Behavioral Finance 42
Predator Prey Game Theory and Behavioral Finance 43
Passive vs Active Game Theory and Behavioral Finance 44
Know your ecology Game Theory and Behavioral Finance 45
Agent Based Modeling Game Theory and Behavioral Finance 46
Yahoo News Error Game Theory and Behavioral Finance 47
Instructions Please write down a number between 0 and 100 (inclusive) such that your guess will be as close as possible to 2/3 of the average guess. Put your name on your card Winner gets $20 Game Theory and Behavioral Finance 48
“Beauty Contest” Beauty contest results (Expansion, Financial Times, Spektrum) average 23.07 0.20 frequencies 0.15 relative 0.10 0.05 0.00 numbers 0 100 22 50 33 Game Theory and Behavioral Finance 49
Beauty Contest Table 1: Data and estimates of t in pbc games (equilibrium = 0) Mean Steps of subjects/game Data Thinking game theorists 19.1 3.7 Caltech 23.0 3.0 newspaper 23.0 3.0 portfolio mgrs 24.3 2.8 econ PhD class 27.4 2.3 high school 32.5 1.6 70 yr olds 37.0 1.1 Germany 37.2 1.1 CEOs 37.9 1.0 Mean 2.18 Median 2.30 Game Theory and Behavioral Finance 50
Hedge Funds & the Bubble Game Theory and Behavioral Finance 51
Clash of the Titans Game Theory and Behavioral Finance 52
Noise Trader Risk Game Theory and Behavioral 53 Adapted from Brunnermeier & Nagel, 2002 Finance
Trend Chasing Game Theory and Behavioral Finance 54
Hedge Funds Game Theory and Behavioral Finance 55
Hedge Funds Game Theory and Behavioral Finance 56
Emotions
Financial Advisors
When does it pay to stick with the herd? Game Theory and Behavioral Finance 59
And when does it not? Game Theory and Behavioral Finance 60
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