Archive for the ‘Game Theory’ Category

Patent Wars

Posted: August 20, 2012 in Economics, Game Theory

The idea of patents made a lot of sense when technological advance was true innovation where blood sweat and tears were poured into the research and development of a new product but these days we’ve got people trying to enforce stuff like “look and feel” as a patent.  The patent wars that we’re currently witnessing between the mobile device firms seems to be a massive waste of money that will only lead to the mutual destruction of all involved.  You would think that the mobile device firms would have realised by now that so long as they are all making money and innovating to ensure future revenue that there is no long term benefit to the extensive legal actions that is probably costing 100s of million in legal fees and damaging the market for all participants. However what will evidently be a very irrational long term impact is essentially fuelled by the very rational short term strategy that creates an escalating hostile environment.

This is actually a perfect example of the “dollar auction” where it is posed that 2 players may bid in whole cents for a single dollar, the winner gets the dollar for their bid, and the loser gets nothing and still needs to pay their bid. It is logical to maximise profit and bid a single cent for that dollar to make 99 cents profit, the second player seeing an opportunity to make 98 cents bids 2 cents and this goes on until the bid is 99 cents where it is then more preferable to bid a dollar and make nothing than lose 98 cents. This then escalates into increasing irrational bids above the single dollar as it is preferable to lose 1 cents as compared to 99 cents and so on.

This game is actually infinite, except in the real world there is a limitation of resources where the first player to run out of resources to bid will essentially lose. While the other player can bask in the light of their victory it should be noted that while they beat their opponent, it came at a massive cost to themselves as well. The patent wars will most likely play out in a mutually assured destruction of the players involved but on the bright side maybe a patent war will teach the world about the follies of actual war… or maybe it won’t.

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A friend recently approached me about share trading (technical trading combined with macro fundamental) as he knew that I have said some incredible insightful things in the past about market movements. He proceeded to ask me how much money I play with on the stock markets and too his surprise I said “Zero”.

He questioned me further as too why I read up and look into these things when I don’t invest, where I simply responded that finance and economics is an interest for me in the same way that other people are interested in sports, and while some people like to put some money down on their interests, gambling isn’t for everyone. Now he was even more confused and said to me that investing isn’t like sports, and went to say that sports is gambling because the outcome is random while the movements of share prices can be predicted.

I gave him credit and said that everything in life can be predicted if you had enough information and the computational power to process that information but for all extensive purposes both are gambling, where share trading is essentially gambling on rationality. Share trading is a game where the decisions of all collective players contribute to form the share price and any purchase of shares on the basis that the price will increase or decrease is reliant on a few key rationalisations;

  1. the share price is undervalued or overvalued, and that this is a rational conclusion
  2. all knowledge required to come to this rational conclusion is common knowledge
  3. all other players think exactly as you do and have come to the same rational conclusion
  4. you are able to come to and act upon such a conclusion faster than all other players

Ignoring the problems 4. creates and assume that you are able to act faster than others; the interesting issue is that 2. and 3. are not a given in reality where if you conclude that a share is undervalued while the majority of other players believe it is overvalued you will lose. Essentially it doesn’t matter what you conclude, you will only win if you can predict what the majority of players will conclude and act accordingly. Since 2. and 3. do not hold in reality, a winning formula relies on having superior knowledge and a firm understanding of how other people rationalise information. In essence, short-term investment is nothing more than a gamble on the rationality of others.

Final Remarks

The common form of this game is known as the Keynesian beauty contest and requires a successful player to be able to discard their preferences and act on the preference of other players. This of course doesn’t count for long term fundamental trading which is about long term performance of the company as opposed to gambling against the rationality of all other players.

I am a little tired of seeing all the media hate around executive pay cheques and I find it insulting that the same media outlets that write “no one is worth that much” will have a whole section celebrating their favourite sporting stars and singers who earn just as much in their early 20s.

Executives earn what they earn for the same simple reason that sporting stars and singers do, that is they are “special” and have unique and superior skills and abilities; the only difference is that executive gained their skills through decades of blood, sweat and tears. The general public rationalise that sporting stars and singers are simply naturally talented and that they themselves would not be able to emulate their performance regardless of how hard they worked at it, so when their favourite sporting stars and singers are reported to earn millions of dollars a year the public don’t think twice about it. However, when the public rationalises that they could do what an executive does and that while that they may not have the skills, knowledge or ability to do the job today, that they could have those things if they chose to. The reality of course is that the vast majority of the public do not chose to put in such decades of sacrifice, and even out of those that do, only a few make it to the top and regardless of this fact they are willing to crucify those who would put in such effort and call foul and inequity. 

Tall poppy syndrome

So why do people suffer from this form of selective tall poppy syndrome?

I would postulate that it is largely tied to the psychology around the perceived rules of the game, where the following beliefs exist because most people are not striving to obtain fame, wealth and power through sporting or musical performance but they are striving for those things working for corporations, and as such they see success in the sporting and music industry as mutually exclusive while empathising with anti-executive sentiments, especially when executives continue to do well and their fellow hard working peers continue to seemingly struggle. 

For someone not in the sporting or musical fields the following would hold true;

  1. The success of naturally talented individuals in sports and music does not diminish their ability to be successful
  2. The success of those in the business world does diminish their ability to be successful, as success if perceived to be a zero-sum game

Final Remarks

The reality would be that executives only seemingly do well in good and bad times because there needs to be leadership in corporations regardless of economic conditions. To penalise corporate leadership under a crab mentality in bad economic conditions would only undermine the efficiency of the economy further. I would say education is the answer but unfortunately tall poppy syndrome and crab mentality is something that will always exist. Even if educated there will always be people that are willing to drag other’s down at a cost to themselves but I’ll leave that topic for another time.

Group think and false-consensus compounded by the presence of confirmation bias can be a very frustrating in a decision making environment. In a business setting it is common for group think to occur as the fear of feather ruffling and desire to appease others  creates problematic conformity at the cost of independent critical thinking. Groups that then come to an immediate conforming opinion assume that this quick alignment can only be because the decision was simply the natural solution, they then project their ideals onto the wider audience under the assumption that their opinions are shared under the false-consensus phenomenon. Lastly the group seeks out evidence that reinforces their beliefs while selectively ignoring information that contradicts them.

Group think

Group think is the problem that occurs when the desire for harmonious decision making hinders the group’s ability to critically think and assess alternative views.

False-consensus

False-consensus is the problem that arises from people’s tendencies to assume that they are the epitome of normality and that the majority of people share the same beliefs and values as they do.

Confirmation bias

Confirmation bias is the problem that arises where people selectively acknowledges information that reinforces their beliefs and values or selectively ignores information that contradicts their beliefs and values.

Final remarks

For a business to stamp out these traits it needs to come from the top, opposition should not be punished simply as a matter of pride and it needs to be made clear that questioning and contradicting those around you is not only acceptable but expected as part of a 360 sanity check of business decisions. Staff should also be encouraged to widen their horizons and understand the strategic objectives of the organisation, applying critical thinking around how decisions line up with strategic direction.

Value is an interesting topic but the concept of influence and deception is much more practical to understand. To look at the concept of value and how societal influence and deception affects us, it is important to start with a conceptual basis of how valuation is generated from an individual’s perception.

Perception of Value

The value of the product could be described as the relative alignment of products functionality and the desires of the individual, since each individual has different desires the value of any specific product will be different for each person, even when two individuals value a product exactly the same, it may not be for the same reasons.

Value = F(Maximum Value, Individual Desires, Product Functionality)

The actual form could be very different for product to product but an example could be;

Value = Maximum Value/ (1+ |Individual Desire – Product Functionality|)

The problem of course is that individuals have multiple desires and a product will have multiple functionalities that need to be taken into account at the same time. This can be represented by mapping the individuals desires as a position in N-dimensional space where each dimension represent a different attribute, similarly the product can be mapped onto this N-dimensional space based on its functionality in each attribute.

If the product matches and satisfies all the desires perfectly the value is maximised the problem however is that the individual cannot perfectly know the position of the product and as such most determination of value is a guestimate of the distance between them and the product. Human’s being the clever problem solvers that we are fill these gaps of knowledge by crowd sourcing information from others.

Crowd Sourcing

In crowd sourcing information the problem is that everyone else essentially has the same problem in that they do not have perfect understanding of all things either.  This leads up to the two strategies in estimating the position of the product;

  1. Find people that are exceptionally skilled at pinpointing the position of each attribute and piece together the product co-ordinates
  2. Triangulate the position of the product by using the estimates of the value and knowing the positions of those providing the estimates

Influence

Now that we understand how our perceptions of value is crowd sourced let’s talk about influence. Influence is a measure of trust and authority and influence can be generated in a few ways but in reality this translates to trusting friends on the basis that they may have similar interest and taste, and trusting subject matter experts because they have extraordinary skill in estimating value in certain attributes.

Deception

So now that we have a way to measure influence, deception becomes a problematic issue. If the source that you place your trust in, is simply deceiving you then this will lead you to estimate incorrectly the value of the product. This in itself can bring up a series of other games with regard to motivation and self-interest but let’s stick to the 3 broad and basic forms of deception;

  • Legal and unintentional, otherwise known as over-confidence
  • Legal and intentional, otherwise known as advertising
  • Illegal and intentional, otherwise known as fraud

We do not include illegal and unintentional because from the sources point of view they were not trying to do anything illegal as it was unintentional.

In terms of over-confidence, this is simply when the source believes they have a reasonable estimate of the relative positions but actually doesn’t, this may be because they themselves have been deceived or sometimes it’s just cause they wanted to sound like they knew what they were talking about.

Advertising is something we all get exposed to everyday and its simple to see that advertising’s purpose is to provide information but more importantly alter perception by bringing the product much closer to you by moving your desires and position closer to the product. If your position is moved permanently then advertising is a source of information and if it is only moved temporarily then its a source of deception.

Fraud is when someone has purposely tricked and altered your perception by feeding you false information for self-benefit. Remember these are broad and basic descriptions, and in no way am I suggesting that it’s a crime to tell someone that they do not look fat in those jeans.

Final Remarks

The next time you’re about the buy a product think about why you’re buying it, how the functionality lines up to your desires, how your perceptions have been influenced and whether or not you’re being deceived.

Not quiet how it originally goes but the tagline sums up my philosophy of life, I have always seen the world and everything in it as a series of games, and the one thing I can’t resist is a game. This blog is set up so that I can record my thoughts and observations about the world around me.