Financial Markets Approached by Game Theory

Otman Javier Gordillo To what extent game theory is a helpful approach to the financial markets
Game theory is the science that mathematically captures the behaviour of agents (humans, nations or animals) in strategic situations (when the individual success depends on the choices of others players). Before it, election choice was framed in the idea of individual election without interaction among agents, situation that biased social sciences’ analysis because in many cases, one agents’ response reflects not only his or her preferences, but also preferences of other agents in the “game” (Owen, 2008). In this sense, game theory brought to social sciences tools to realistically analyse interactions among individuals. It was initially introduced by von Neumann and Morgenstern in 1944 and Nash in 1950, and since then, it has been increasingly used not only in economics, but also in computer science, engineering, biology, political science, international relations and even philosophy. Financial markets have been not isolated of the influence of game theory: it has affected theory foundations, market analysis and trading methods. Indeed, its influence has been so important that The Economist (1996) said that “managers have much to learn from game theory — provided they use it to clarify their thinking”; in a similar vein The Wall Street Journal (1995), the most influential business newspaper said “game theory is hot”. The purpose of this essay is to unveil the revolutionary applications of game theory not only in finance theory, but also in trading, pricing and agents’ competition (every day finance or real finance). This document will focus on three foremost aspects: first, the analysis of the financial market as a game to point out the capability of game theory to analyse markets. Afterwards I will focus on the contributions of game theory to the development of modern finances mentioning asset pricing’s approach, invertors’ unusual behaviour and analysis of interaction

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