Game theory, dating & investments

My friend ran into an interesting dilemma on her last date.

Let’s call my friend X and her date Y.

X and Y met up for coffee. X felt hungry but Y was not. After a while, she was famished so she ordered something to munch on. When the bill came, Y gave no indication of paying. So X reached into her wallet to produce her credit card. The cafeteria told her that they did not accept cards. She barely had sufficient cash. As a result, Y had to hand out the dough.

Here is her take on the incident.

The first time they went out, Y paid.

The second time, when X offered to pay, Y obligingly passed the bill to her.

This time he was not too eager to settle it, probably on the presumption that she was the one who was famished and placed the order so it was her responsibility.

Besides feeling a bit embarrassed at not having money, she was perplexed: “Has he now assumed that I will be the bankrolling most of our dates”?

I am not taking sides here but I don’t blame him. A significant part of his young adult life has been lived in the shadow of a recession. Secondly, he does not know if the girl is stringing him along so is obviously playing it safe by not being fiscally macho. Unless you are a hippie of some sort, money is a big deal and nothing screams “loser” louder than the realization (in the “post-getting dumped” scenario) that all the reckless spending in the early days of the relationship amounted to nothing but a busted ego and a lighter wallet.  

Neither do I belittle my friend’s concern since the same logic holds true for her too.

If you have ever dated, you would have certainly encountered such situations which have all the potential to ruin a relationship. Don’t scoff! Researchers like David Buss (author of The Evolution of Desire), believe that the human brain and cognition evolved as a consequence of problems posed by complex social relationships. Which probably means that the human brain has reached its current size mostly to figure out such social dynamics (did you know that we have bigger brains than most animals?). Maybe we could learn a lesson or two from elephants and whales since their brains are bigger than ours.

So how should the next date play out? Should he pay the bill? Should she reach out for the bill? Should they alternate paying for it? Should they split it everytime? Should she bring up her concern?

Let’s see what game theory has to say. Game theory can be applied to anything: international diplomacy, war, love, dating, evolution or business strategy. A report in the New York Times claims that it can even be applied to whether or not you should wait for the bus.

According to this theory, a game is any situation in which one player makes a decision that affects the other (let’s restrict it to two players). So, even though X and Y are just dating and not playing games, by the definition of this theory they unconsciously are. The game begins with one player making a choice (a move) resulting in a situation the other reacts to (resulting in another move). So their social interactions over time are just a combination and culmination of many games (goodness, economists are really so unromantic!).

The essence of the theory is that the action of each of the rational adversaries would depend on what the other side was likely to do. But real life scenarios are much more complicated than a mathematical model. It also involves understanding your opponent in the game. If you think he is rational but he is not, then your moves could backfire.

In game theory, you cannot master the game because it is not technicalities at play here.  

You cannot ask: What is the best way to date?

Instead, go with: Is there a better way to date in this situation?

In my friend’s case, the best way to tackle the situation would not be to play the game with the idea of beating the opponent but to just do well for herself. Since they both enjoy each other’s company, the best outcome would be one that comes out of a cooperative stance.

In that case, she can immediately suggest at the next date that they go dutch.

Or, she could just wait for him to pick up the tab.

Or, she could go along with the flow. If he does not pick up the bill and she finds herself footing the bill most of the time, she can either suggest at that time they go dutch or tell him that she finds it unfair. His move will then determine the direction the relationship will take.

A cooperative strategy (as against a non-cooperative one in game theory) would help them both reach a reasonable solution.

Paula Szuchman, author of a book on relationships and game theory, says that if game theory teaches us anything, it’s that relationships are not about having it all. It is about achieving the best possible result under the circumstances. Well said Paula!

If such relationships are based on the cooperative strategy, some will benefit from the non-cooperative one. Professor Kenneth Binmore, who researches game theory, was widely known for his role in designing the UK 3G Spectrum Auction, which was rumored to be based on game theory. Auctions are a sort of game with rules of the game, allocation rules and bidder strategies. The aim is to sell an object to bidders whose valuations are unknown to sellers and other bidders. The auction outcome is then determined via a non-cooperative game played by bidders under rules determined by their beliefs about the good’s valuation and/or signals from other bidders.

In the case of investments, game theory principles can be enlightening. When you decide to buy a stock, many players come into the picture immediately. If banks hike up their interest rates, the company that you invested in may find itself steeped in too much debt. If a competitor enters the market and the company loses market share, profits will be hit. This will result in analysts downgrading the stock resulting in the price falling.

You cannot play the market and expect a “guaranteed” win because there are too many players in this game. And not all players have the same level of information or the ability to interpret it accurately.

Of course, a stock trader could make an assumption that given a particular amount of volatility or level of the Sensex (or any other index), one strategy would be preferred over the other. But then you have situations like the Kobe earthquake of 1995, the Asian financial crisis of 1997, the Russian bond default of 1998, the 9/11 terrorist attack in New York in 2001, the credit crisis of 2008, the ongoing Euro drama and the entire game can be overturned by such external factors. So it's not just the uncertainty due to actions of the other players, there is also uncertainty due to randomness.

But one way or the other, game theory touches all of our lives. :)

Disclaimer: I am NOT an expert on game theory and my knowledge on the subject is woefully stunted. If I have erred, I am dreadfully sorry... :(

Food for thought, fodder for investment

I am no rabid chocoholic. 
But I am inexplicitly drawn to the price of cocoa (which, in case you were unaware, is an ingredient that goes into the making of chocolate). 

I guess Armajaro's antics are what got me hooked. 

This firm has a reputation for its audacious gamble on the humble cocoa bean. The last “heist” (if it can be called that) was in July 2010 when the firm reportedly purchased around 240,100 tonnes of cocoa beans, worth more than $1 billion, sending the spot price of cocoa skyrocketing to a 32-year high. Co-founder Anthony Ward probably bought it on the presumption that the next cocoa bean harvest would be a poor one, driving up the price of the commodity and catapulting him to chocolate heaven. 

In most transactions, traders exchange contracts to buy and sell the commodity at various prices but do not take physical possession. This time, actual delivery took place and the mountain of beans was most likely stored in warehouses across England and The Netherlands. 

To drive home the magnitude of the trade, the media had intriguing parallels to ignite someone’s imagination. That investment could have materialized into more than 5 billion small chocolate bars. Or, try this: It was sufficient to fill 5 Titanics (credit for that goes to the then-chairman of the Financial Services Club, Chris Skinner, in an interaction with BBC).

Armajaro did not confirm nor deny the reports, but the street knew it. In 2002, Ward pulled the same stunt when he purchased 204,000 tonnes of cocoa at a time when supply was limited because of poor harvests and political instability in West Africa. The Daily Mail reported that he made more than £40 million in just two months after the price of the commodity rose steeply from £1,400 to £1,600/tonne. Traders at that time nicknamed him Chocfinger after the Bond villain Goldfinger.  

Such speculation (and stockpiling) in the notoriously fickle and famously unpredictable commodity markets stifles supply and forces the price even higher.
So why am I reminiscing about him now? 

Because prices of commodities are going through the roof. Bloomberg has reported that money managers recently raised bets on higher prices for cocoa which has hit a 9-month high at the start of the month on the back of poor weather conditions. Incidentally, the last I heard of Chocfinger was when I read that the price of cocoa dropped by 26% resulting in a huge loss on his position. Not the first time he would have lost. Ward had dabbled in another cocoa bet in 1996 which backfired when the firm had to unwind the trade after a slump in cocoa bean prices.

Speculation is a dangerous game. Mark Twain would know. He was an avid speculator who went bankrupt before the age of 60. His words of wisdom stemmed from painful experience: "There are two times in a man's life when he should not speculate: when he can't afford it and when he can". Touché!

But I doubt Twain speculated in agricultural commodities which has taken on a moral dimension. According to the United Nations Food & Agriculture Organisation (FAO), excessive food price volatility and the speed at which price swings have been occurring over the past few years has resulted in a "human impact" driving home the point that food commodities cannot be used as pure financial instruments. In the past few years, there have actually been food riots across the globe caused by rising prices. 

A report by the Institute for Agriculture & Trade Policy states that food and energy prices have become linked and unstable over the last decade largely due to speculative investments. 
The Independent has stated that investments in food commodities by banks and hedge funds has risen from $65 billion to $126 billion over the past five years. This has pushed prices to 30-year highs causing sharp price fluctuations that have little to do with actual supply of food. The likes of Goldman Sachs, Morgan Stanley and Barclays Capital dominate the food commodities market. 
Commerzbank has restricted investments in agricultural products after accusations that speculation has pushed up food prices and fuelled unrest in some poor countries. 

While there are ethical implications to commodity speculation, I am not saying I subscribe to the unvarnished view that speculation is the sole cause of price volatility. I believe it does exacerbate swings in prices already vulnerable to climate shocks, lack of investment in agriculture, rise in global food demand, decrease in per capita arable land and the loss of agricultural land to grow biofuels. And it is because of such factors, I doggedly believe that an investment in agricultural stocks would be a shrewd diversification in an investor's portfolio over the long term. Don't speculate. But profit from volatility and invest in an opportunity. 

Perceptions, Presidents & Investments

When I think of perceptions, my mind goes back to former French President Nicolas Sarkozy.
At the start of his term, he was France’s most popular leader since World War II hero General Charles de Gaulle. Five years down the road, he was the most unpopular incumbent French president since the war. 

He appeared refreshing at the start, but intolerable towards the end.
Once people began to perceive him differently, it overrode everything else.
When they finally voted him out of office, it was almost a personal referendum on him.

Daily Mail nastily referred to him as a man who wants to be Steve McQueen. 

Guardian  commented that he was “shamelessly admiring of money and those who have it…”
The flamboyant Sarkozy had expensive tastes in accessories (who can forget the Rolex and Patek Philippe wristwatches and Ray-Ban sunglasses?) and made a glaring faux pas when he celebrated his election victory at Fouquet’s, a fancy restaurant on Paris’s Avenue des Champs Elysees, with a dozen of his rich buddies, and then sailed away on a yacht belonging to one of them.

He later said that he regretted both those moves and blamed it on his “disorientation” because of his troubled second marriage. A laughable explanation which was scoffed at by the public because he ended up getting married rapidly– just three months after divorcing existing wife and two months after meeting the new one – to an ex-supermodel whose past conquests reportedly include Eric Clapton and Mick Jagger.

Guardian also said that he was “pushy, vulgar, uncultured, impetuous, in-your-face-rude….” 

Poor Sarkozy, he asked for it. He was caught on video an at agricultural fair saying "Sod off..." to a man who refused to shake his hand; audaciously sent text messages to his wife during an audience with the Pope; imprudently paraded his first public date with Carla Bruni at Disneyland weeks after his high-profile divorce and brazenly turned up at the presidential palace in jogging shorts and shoes on his first day in office.

As perceptions changed, it turned out to be politically suicidal. Sarkozy would have learnt that much of what happens to us in life hinges on how we are perceived by others. 

But perceptions don't just affect how we are viewed and treated. Perceptions also drive our decisions - most of them.
At this point, my thoughts go to the US presidential campaign.
Paul Ryan’s selection as Mitt Romney’s running mate has got tongues wagging and keyboards punching away opinions on what this means for the campaign.

While Examiner has said that Romney is playing to perceptions, Daily Caller refers to Ryan as doing a “wonderful job wrapping himself in the mantle of a fiscal conservative, but there simply isn’t any evidence to back up the perception.”

Here’s their take on bipartisan.

Democrats want Ryan perceived: as a fiscal conservative so they can condemn him as a draconian slasher who wants to gut essential government programs and drag them back into the 19^th century.

Republicans want Ryan perceived: as a crusader against the bloated federal budget and the perfect “bridge” pick to help Romney attract those fickle budget hawks and libertarians to his cause.

What Ryan really wants: To drastically increase the size and scope of the federal government. Since the truth is not useful to either major party, it’s discarded.

Ryan is perceived as bold and decisive, and intelligent and articulate, just what is needed to give a new dynamic to Romney’s campaign that was running out of steam. 

Examiner is probably spot on when it states that in politics perception is reality. 

What about investments?
Don't perceptions influence our decisions? Does perception become our reality?

Seeking Alpha tackled this well. 

Company A: a money-losing socially networking company in an exciting growth market
Company B: a profitable and mature enterprise in the unattractive traditional media space 

Company A enjoys an excessively elevated valuation in relation to Company B, despite the fact that Company B is profitable and has a long history of stable operations and reasonably stable outlook.

Company A’s valuation is driven by a perception of strong growth going forward and will be favoured by growth investors; Company B is perceived to be in a mature industry and thus not worthy of a valuation close to Company A but will be eyed by value investors. 

The article goes on to explain how perception will eventually influence a few of the basic fundamentals of the company. But I need not go into that here.

My point is that perceptions matter when deciding where to put your money. Have you not gravitated towards a larger fund simply because you perceived that if many put their money there it is probably good? After all everyone cannot be a sucker. Take heed, the Goliaths are not always superior to the Davids.  
Bigger does not necessarily mean better. 

A parallel can be drawn in sport. Livestrong argues that fist size or hand size does not make much of a difference in martial arts or boxing. It is the force behind the punch and the technique that is used in delivery. Make sure your fund manager has more hits than misses and is not simply riding a heavyweight.  
Size does not always matter (in investing). :) 

Love your diamonds, don't invest in them

The other day I went diamond shopping.

Let me re-phrase. My friend went shopping for diamond jewellery, I tagged along for the ride.

And, much to my surprise, I was bowled over. An exquisite Stephan Hafner bracelet of white gold in an irregular shape, studded with black and white diamonds took my breath away. A love-at-first-sight, passionate, but completely one-sided, encounter ensured for precisely the next 10 minutes.
After fawning over it and trying it on, I let it go with the declaration that I don’t wear hand jewellery. Which was the truth. What I did not disclose was that even if I did attempt to change my style, the price tag of Rs 5 lakh was sufficient deterrent.

My friend attempted to persuade me otherwise with the spiel that jewellery is a good investment. Which in my book is utter nonsense. Men buy jewellery for women. Women buy jewellery for themselves. None do it from an investment point of view. 

So why do men buy jewellery for women?

In his book Call of the Mall, Paco Underhill claims that jewellery has traditionally been purchased by men for women for one of three reasons:

1) Keys to the front door: When men want to make blatant declarations of affection or intention they gift jewellery on special occasions - engagement, marriage proposal, anniversary, birthday.

 2) Keys to the back door: When they need the convenience of a relationship but want to bypass all the commitments that come with front-door entry. Hence, mistresses, secret lovers and girlfriends are recipients of jewellery.

3) Keys out of the doghouse: This is their way of saying sorry and want to make amends for bad behavior. Flowers wither too quickly, perfumes don’t last forever and chocolates will only make you fat. Nothing says “sorry I have been a jerk” better than a fine necklace or diamond earrings.

Why do women buy jewellery for themselves?

1) To show off their own personal wealth

2) To show off their husband’s wealth

3) To strike envy in the heart’s of others

4) To feel good by doing either one or all of the above

Of course, I make allowances for one exception here. If you have amassed a great collection and achieved iconic celebrity status in the bargain, then jewellery is a great investment. In December 2011, Christie’s New York conducted an auction of Elizabeth Taylor’s jewellery. The sale drew unprecedented interest from bidders throughout the world with 36 different countries represented during the four days of live auctions. It fetched $156.8 million!!!

Back to my doggedly relentless friend. “So why can’t you invest in that bracelet? You can wear it. You can sell it should the need arise. And, for heaven’s sake, you loved it!”

Because, my dear, I will not invest in anything I love; it would break my heart if I have to sell it. Even Elizabeth Taylor got her collection sold after she was no more.

So does that mean I would never invest in jewellery?

Let me put it this way.

When I buy jewellery, it is to wear it and flaunt it. Precious stones and precious metals are meant to grace the body. I don’t expect to recoup their value by reselling one I bought at the retail level at a very high mark-up. At a resale, I will never get the true value of the investment.

When I want to invest in precious stones and precious metals, I look towards mining companies. Because then I am completely non-emotional in my decisions. But it also means that I am not buying the precious metal or stone directly, I am buying into a company that mines it. 

Happy Anniversary!

Actually, there is nothing happy about it. 

Today marked 5 years since the start of the financial crisis. 

On August 9, 2007, French Bank BNP Paribas froze withdrawals on three money market mutual funds that had an exposure to US subprime mortgages. This alarmed global banks, who immediately stopped lending to each other. 

The credit freeze instantly turned ugly forcing the European Central Bank (ECB) to pump in €95 billion into the financial markets to free up the flow of capital between banks. This was the first time since the 9/11 terrorist attacks in New York that the ECB had to so dramatically step in to prevent the US sub-prime mortgage virus from spreading through the  German, French and Dutch banking systems. 

Wall Street’s Dow Jones index tumbled 387 points and the US Federal Reserve injected $24billion into the banking system, while the Bank of Canada said it was ready to provide liquidity.

A vital nerve in the international finance system was touched. Life after that would never be the same in these circles. 

President George Bush passed an ironic comment that day: "The fundamentals of our economy are strong.” Yes, Mr ex-President, in retrospect, we all know how that eventually played out. 
A year later, the credit crunch eventually led to the collapse of Lehman Brothers and triggered the deepest global recession since World War II.