The Application of Basic Game Theory in Financial Decision-Making (Advances in Economics Management and Political Sciences)

Summary

• The paper reviews how basic game theory explains strategic interaction, information asymmetry and equilibrium outcomes in financial markets.p.1
• It focuses on three areas: investment decisions, market information efficiency and IPO pricing.p.1
• Grossman and Stiglitz show that perfectly informationally efficient markets are impossible when information acquisition is costly.p.1
• Rock's model explains IPO underpricing through asymmetric information between informed and uninformed investors.p.1
• The paper concludes that game theory is useful but limited by rationality assumptions, market complexity and the difficulty of measuring information asymmetry.p.1

Key insights

1. Investors, firms and underwriters do not decide in isolation, since their choices depend on expectations about others.p.2
2. Financial decisions often resemble games rather than simple individual optimisation problems.p.3
3. Markets may reach an equilibrium in which some investors become informed while others stay uninformed.p.4
4. To attract uninformed investors, issuing firms must offer IPO shares at a discount.p.4
5. Future research may combine game theory with behavioural finance, big data and artificial intelligence.p.5
6. Future models may need to consider higher-order beliefs, meaning what investors believe others know.p.5