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January 10, 2014

Game Theory & the Future of Financial Services

Posted by Rajashekara V. Maiya (View Profile | View All Posts) at 5:58 AM

Applying Game Theory to Your Trading [Source: http://www.youtube.com/watch?v=rhNzdHlDE4U]

One of the more talked-about movies of the winter season is "The Wolf of Wall Street," a high-octane story about the greed and excesses of a bunch of poorly behaved stockbrokers in the early 1990s.

An academic view of the movie would remind us that game theory - the same tenets of which explain why cricket players decide on certain strategies in order to win their matches - is front and center in any story about the stock market. That's because the capital markets are very much the end result of passionate, very emotional decisions as to how best to invest money. Financial services firms have been trying to tap into how their customers think and act as a way of better serving them - and, of course, improving their bottom lines.

One of the most exciting developments in the field of behavioral science involves looking at how game theory can be used to explain a host of human interactions. Video games have gotten very sophisticated over the past few decades. Their graphics are such that they appear incredibly realistic. But they're also sophisticated in how they connect large numbers of people from all different parts of the world. Some of the most popular video games require online gamers to work together to accomplish a certain task.

In the early days of this type of game structure, the companies found that certain gamers would act maliciously simply because they didn't know their other teammates, who might each be sitting on a different continent. Then the companies brought in behavioral scientists to decipher why people were acting the way they did in an attempt to create a nice experience for everyone. One of the byproducts of their studies was that what motivates online gamers is not much different from what motivates people in the offline.

Of course, Nobel Prize-winning economists have utilized game theory for generations to explain why the financial markets move the way they do. (Their movements are what makes "The Wolf of Wall Street" such a controversial movie.) But game theory applied to millions of online video gamers has significantly increased the scope of how scientists can investigate what moves us.

Big Data has become one of the most important aspects of a company succeeding in the modern marketplace. That's why, I think, the study of video gamers is so relevant to the investment banking and capital markets arms of the financial services vertical (along with the study of retail and corporate customer behavior). Instead of creating a virtual set of experimental subjects, the people who play large-scale, globally based video games are real. So these huge field experiments allow enterprises to study and anticipate complex social interactions that produce purchase of products and retail trends.

My sense is that the coming year will see studies like the ones surrounding video gamers becoming even more preponderant. We're looking at a new paradigm of finding ways to tap into the mind of the modern consumer. Plus, the fact that financial services companies can learn from what video game companies have produced also hints at the interplay of ideas across sectors and industries.

Think back to just a few years ago, when economists at universities would undertake studies that existed for the most part in their separate silos. Seldom did major findings find applications in the world of consumers and retail, not to mention financial services, in a rapid and seamless manner. It usually took years for ideas such as game theory to be utilized by enterprises in order to better suit their consumers. Now, however, Big Data and the ability to parse it allow us to look at vast chunks of society and analyze how these swathes of humanity think and act in various situations. And the outcomes have almost real time applications to enterprises that are looking to better engage the digital consumer. It's gotten to the point where any consumer (or would-be consumer) with an Internet connection can now aide companies that want to refine their products and services.

The key now is how these companies will get to that data and how they'll analyze it. The coming year will be filled with exciting, innovative solutions to commercial problems that used to give enterprises more pain than gain.

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