Credibility of the ThreatsGame Theory Applications to Finance and Consulting CasesFinance 750: Independent Study ProjectWinter 2001Instructor: Galina A SchwartzOffice: D3270APhone: 764-3175E-mail: [email protected] Website: http://www.citi.umich.edu/u/galka/gamesOffice Hours: Monday 10:00a.m. - 12:00p.m. Thursday 1:00p.m. - 3:00p.m. (or by appointment).ScheduleS e c t i o n Day Time Room001 Mon/Wed1:00 p.m. - 2:30 p.m. K1230Midterm: Take homeFinal: TBACourse Objectives The class is a non-technical introduction to game theoretic analysis. We willcover the major principles and methods of game theory with application tofinance and consulting cases. We will study the determination of the set ofrelevant players, their strategies, and the set of actions they are likely toundertake (i.e. their equilibrium actions). We will introduce a notion of Nash equilibrium, and of a subgame perfectequilibrium. We will introduce basic types of the games (Prisoners dilemma, zero-sum and non zero-sum games, etc.), which frequently occur in financialenvironments. We will learn how to recognize these games in real life situations,and how to choose the best-suited game to analyze a specific business case.The class targets MBA students planning careers in financial or consultingindustries.Grading and RequirementsThis course will have three homework assignments, one case study a take-homemidterm and a final exam. The written assignments and the midterm are due atthe beginning of the class in which they are discussed. Students are encouragedto work together and turn in the written assignments, which are optimal: thehomework grade could be substituted by the class participation grade1. Write-upscould reflect the work of up to 4 students.Good questions are purposely written to be ambiguous. While there are no rightanswers, there are good and bad arguments. If you are uncomfortable withambiguity you should reconsider taking this course, or prepare to deal with thesubject where ambiguity is an essential feature. Attendance: The subject of international finance is conceptually demanding andhardly could be mastered through an independent self-study. Thus, attendance oflectures is crucial to absorb the material. Attendance and promptness will berewarded accordingly.Midterm exam: (Take home) 30%Final exam: (Take home?) 40%Homework / Class participation: 30%,Students will have an option to re-weight the final at 70 % of the total grade(dropping off the midterm grade). A handwritten ‘cheat sheet’ will be permitted on the Final exam. Also studentscould purchase extra exam time: its cost is 1 point reduction of their exam scoreper extra minute (the total score for each exam is 100, with up to 10 additionalbonus points). No make-ups will be allowed, except with a formal excuse fromthe Academic Services Office. Grade Appeals: Grade appeals are in writing only, and have to be submittedwithin 5 days after the date when the written work is returned. Prerequisites: BE 501 (can be taken concurrently). Background in game theoryis not required. Ability to think is not required, but is highly desirable.How to enroll (and get credit): The course does not have the number. Thecourse number will be designated if academic services will require. Independentstudy project gives you the same credit as one seven-week course, which is 1.5credit hours.Readings: The primary readings will come from an excellent textbook): Dixit, A.and Skeath, S., (1999), Games of Strategy (further Dixit). Lecture notes andrelevant excerpts from various publications will supplement the textbook. Caseswill be drawn mostly from Lewis, Michael, (1990), Liar's Poker (further Lewis).Some readings will be posted as pdf files. Thus, students will need AdobeAcrobat Reader (see www.adobe.com/prodindex/acrobat/readstep.html). In1 That is, 30% of a student’s grade will be determined by either the student’s homework or classparticipation grade – whichever is higher.Syllabus: Game Theory Applications to Finance and Consulting Cases 2order to disseminate the class materials efficiently, it is advisable to heck the website in advance (i.e. within 24 hrs) of each class. Most course materials will bedistributed in class and posted on course web site, and linked to my home pageat http://www.citi.umich.edu/u/galka/gamesIntroduction. Course Overview. Subject and Structure of the Course [1 Lecture]Terminology and Background Assumptions [1 Lecture]Classification of the Games Examples of the Games [1.5 Lectures]Complete and Incomplete Information games, Repeated and Non-repeatedGames, Games with Simultaneous Moves and Games with Sequential Moves, Prisoner’s Dilemma, Coordination Game (Battle of Sexes), Zero-sum (andConstant Sum) games, Dixit, Chapters 1 & 2, (R).Levis, Chapter 1, (R).Games with Sequential Moves [1 Lecture]Games with Simultaneous Moves [1 Lecture]Dixit, Chapters 3 & 4, (R).Levis, Chapter 3 & 4, (R).Super Games (Infinitely Repeated Games) [1 Lecture]Equilibrium Derivation for Infinitely Repeated Prisoner’s Dilemma, DiscountFactor Interpretation as Probability of Repetition, Examples: Cartel SustainabilityGame Theoretic Experiments [1 Lecture]Evidence: Divide a Dollar Game, Centipede Game, Explanation of Cross-Country Differences, Social NormMixed Strategy Equilibrium [1 Lecture]Dixit, Chapter 5, [parts] (R).Notion of the Subgame-Perfect Equilibrium [0.5 Lecture]Credibility of the ThreatsDixit, Chapter 6, [parts] (R).Syllabus: Game Theory Applications to Finance and Consulting Cases 3Bargaining Theory [2 Lectures]Ultimatum game, surplus of the game, Rubinstain Bargaining Model (AlternatingOffers Model), delay, impatience, outside option, manipulating information,ExampleDixit, Chapter 16, (R).Auction Theory; Conclusions & Course Summary [2 Lectures]Types of Auctions, English (ascending), Dutch (descending), First Price, SecondPrice, Common Value (Objective Value), Private Value (Subjective Value),Auction design, Winner’s Curse, Vickrey’s Truth Serum, Revenue EquivalenceTheorem, Bid Shading, All-Pay Auctions, Risk-Neutral and Risk-Averse