The Application of Basic Game Theory in Financial Decision-Making

Abstract

This paper examines the application of basic game theory in financial decision-making, with a focus on strategic interaction, information asymmetry, and equilibrium outcomes in financial markets. Traditional financial decision-making models often assume that market participants act independently and have access to similar information. However, in reality, investors, firms, and financial institutions frequently make decisions by predicting the behaviour of others. Based on the theoretical foundations of von Neumann and Morgenstern's game theory and Nash's equilibrium concept, this paper reviews how game-theoretic models can explain important financial phenomena. It mainly discusses three areas: investment decisions, market information efficiency, and IPO pricing. Grossman and Stiglitz's model shows that perfectly informationally efficient markets are impossible when information acquisition is costly, while Rock's IPO underpricing model explains how asymmetric information between informed and uninformed investors leads to discounted offer prices. The paper concludes that game theory provides a useful framework for understanding financial decision-making, but its application is limited by assumptions of rationality, the complexity of markets, and the difficulty of measuring information asymmetry.