Why Game Theory Blows Up in Financial Markets

New paper on why game theory falls down in the real world of complicated games, like financial markets:

Complex dynamics in learning complicated games

Tobias Galla, J. Doyne Farmer

Game theory is the standard tool used to model strategic interactions in evolutionary biology and social science. Traditional game theory studies the equilibria of simple games. But is traditional game theory applicable if the game is complicated, and if not, what is? We investigate this question here, defining a complicated game as one with many possible moves, and therefore many possible payoffs conditional on those moves. We investigate two-person games in which the players learn based on experience. By generating games at random we show that under some circumstances the strategies of the two players converge to fixed points, but under others they follow limit cycles or chaotic attractors. The dimension of the chaotic attractors can be very high, implying that the dynamics of the strategies are effectively random. In the chaotic regime the payoffs fluctuate intermittently, showing bursts of rapid change punctuated by periods of quiescence, similar to what is observed in fluid turbulence and financial markets. Our results suggest that such intermittency is a highly generic phenomenon, and that there is a large parameter regime for which complicated strategic interactions generate inherently unpredictable behavior that is best described in the language of dynamical systems theory.

via [1109.4250] Complex dynamics in learning complicated games.

Naturally Occurring Experiment: The Jeopardy Tournament of Champions

Interesting new paper:

The Liability of Leading: Battling Aspiration and Survival Goals in the Jeopardy! Tournament of Champions

We extend the variable risk preferences model of decision making to a competitive context in order to develop theoryabout how competition affects both focus of attention and risk taking. We hypothesize and find support for leader–follower differences in the channeling of attention to an aspiration or survival point. Our results indicate that leaders focuson their aspiration point, whereas followers’ focus of attention shifts between their aspiration and survival points. By identifying and elaborating on the different cognitive loads and social expectations related to the positions of leader and follower, we show that leaders are prone to take excessive risks to maintain their leadership position. We refer to this phenomenon as the liability of leading. Our study context is a naturally occurring experiment in strategic decision making, the Jeopardy! Tournament of Champions.

Twitter Digest: 2011-10-03

  • Fawlty Towers: "Communications Problems". Such classic TV. http://t.co/9YZizvOj ->
  • Super Atlantic photo set – World War II: The Allied Invasion of Europe http://j.mp/nago0z ->
  • Cute geek punning: "Fossworldproblems" on Reddit – http://t.co/9vtT6QzC ->
  • Just what I need: People talking to their iPhones even when they're not talking on the phone. Please, no. ->
  • Leopold Kohr fifty years ago on the inevitable 'crisis of bigness' http://t.co/D8bJw7sZ ->

Alex Honnold on 60 Minutes

When stuff happens on “TV” I miss it all the time. Apparently free solo climber Alex Honnold (of Alone on the Wall fame) was on 60 Minutes, and so … the clip follows. Warning: Whoever the woman who hosts this segment might be, she doesn’t know climbing.

Stuff ‘n’ Things

Just back from a week in Europe. Totally exhausted still. Some catch-up.

  • Real Men Don’t Miss a Season (Source)
  • This Season’s Snowiest Resorts (Source)
  • The Wirecutter | A List of the Best Gadgets (Source)
  • Euro fix a con trick for the desperate (Source)

For those of you interested in other random things financial, a few of my current positions, whether directly or via options:

  • Longs: UUP, GLD, PCY,  RWX
  • Shorts: RIMM, SNE, NOK, SPY, EEM, XLI, XLF, XME, XLK

I’m generally of the view that, assuming the Euro wheels don’t come off first, we get a screamer of a bounce higher sometime soon, and then trade off into Q1 2012, by which time we revisit, say, 800-900 on the S&P as the world comes unglued against $0.80 in earnings on the S&P. Sometime in 2012, likely early, we will get the best prices of the current cycle for equities, and then we will tumble cheerfully deeper into depression as austerity bites hard here and in Europe.

Thematically, I’m still big on the idea that a host of consumer electronics companies being clobbered, mostly while people are ignoring them for some bizarre reason. So I remain in my year-long short in RIMM (even if worried that activists are going to mess me up), SNE, NOK, etc. I’m also short EEM in a paired trade against PCY, largely as a crash trade where emerging sovereign debt outperforms emerging equities. I’m also short a host of U.S. sector ETFs as I have been since June-ish, a trade that started terribly and has done much better ever since.  On the long side, the dollar is another crash trade, which I have done via options in a sort of bull strangle, and I’m also long real estate via RWX, mostly because I like the idea that the second derivative is tapering and people hate it more than I do.

Looking forward slightly, I imagine that we will see that bounce very shortly, and it could be very strong indeed, causing me to hedge these holdings fairly dramatically, and even close a few out.

[Update] Well, that was fast. Apparently we are bouncing right now. Who knew I would call the bounce so closely? Monkeys, typewriters, etc.

Daily Deals: Prediction, Social Diffusion, and Reputatio

New paper:

Daily Deals: Prediction, Social Diffusion, and Reputational Ramifications

Daily deal sites have become the latest Internet sensation, providing discounted offers to customers for restaurants, ticketed events, services, and other items. We begin by undertaking a study of the economics of daily deals on the web, based on a dataset we compiled by monitoring Groupon and LivingSocial sales in 20 large cities over several months. We use this dataset to characterize deal purchases; glean insights about operational strategies of these firms; and evaluate customers sensitivity to factors such as price, deal scheduling, and limited inventory. We then marry our daily deals dataset with additional datasets we compiled from Facebook and Yelp users to study the interplay between social networks and daily deal sites. First, by studying user activity on Facebook while a deal is running, we provide evidence that daily deal sites benefit from significant word-of-mouth effects during sales events, consistent with results predicted by cascade models. Second, we consider the effects of daily deals on the longer-term reputation of merchants, based on their Yelp reviews before and after they run a daily deal. Our analysis shows that while the number of reviews increases significantly due to daily deals, average rating scores from reviewers who mention daily deals are 10% lower than scores of their peers on average.

via [1109.1530] Daily Deals: Prediction, Social Diffusion, and Reputational Ramifications.

Winter. It’s On.

Winter

Twitter Digest: 2011-10-01

Oil: Serial Equities Killer

Oil equ

Twitter Digest: 2011-09-30