The Surprising Applications of Game Theory

Have you ever weighed the pros and cons to make a decision? Or negotiate with someone to get a better deal? If so, you have used game theory in everyday life! 

Before we jump into the many uses of game theory, let's understand what it is. Game theory is an extremely valuable branch of mathematics that offers insights into strategic decision-making across various domains. Simply stated, it is the study of mathematical models to find the most optimized choice and to make strategic decisions.

The first case where game theory proves instrumental is negotiations, where achieving consensus is the goal. By analyzing the dynamics and potential outcomes of negotiations, individuals can strategize effectively. Recognizing the type of negotiation, such as the Prisoner's Dilemma (cooperation vs. defection), Chicken (aggressive vs. submissive), and Stag Hunt (cooperation vs. individual gain), allows you to predict opponents' behavior and formulate appropriate strategies. Additionally, determining one's Best Alternative To a Negotiated Agreement (BATNA) provides leverage and prevents accepting unfavorable deals. Understanding opponents' BATNAs aids in gauging their flexibility and willingness to accept offers. Publicly disclosing BATNAs or limitations enhances the credibility of threats and facilitates successful negotiation outcomes. 

In addition, game theory aids in financial decision-making, particularly in investment strategies. Assessing the risk-reward balance of stocks helps investors make informed decisions on when and where to invest. For example, an investor can choose to invest in individual stocks (high risk, high rewards) or an index fund, which seeks to track the average of one sector of the entire stock market (low risk, low rewards). If they want to (potentially) make lots of money in a short period, they might choose a stock, but if they want to make money over a long time, they would choose an index fund. 

Moreover, game theory guides investors in implementing “counter-herding” methods to capitalize on market fluctuations. Put simply, herding is following what other investors do (if a lot of people sell a certain stock, one would also sell that stock), so counter-herding is people doing the opposite of what people do (if a lot of people sell a certain stock, one would wait until fewer people are selling (meaning less stocks of that kind are on the market) and then sell it). By resisting herd selling and holding onto stocks (which has a similar effect as herding), investors can potentially profit from future market growth. Diversifying investments across various stocks reduces risk and ensures alignment with market trends, maximizing potential returns. 

Lastly, game theory provides strategies for success in card games and gambling. (Just to be clear, I’m not endorsing gambling.) By applying game theory principles, players can optimize their decision-making in games like Texas Hold'em. Maintaining a balanced and unpredictable approach, known as Game Theory Optimal, enables players to navigate the uncertainties of card games effectively. This entails making strategic decisions on folding or raising based on the broader game dynamics rather than solely relying on individual card values. 

In summary, game theory offers practical frameworks for achieving favorable outcomes in negotiations, investment endeavors, and recreational activities, enabling individuals to make strategic decisions in competitive environments.