Mathematical Finance Seminar

February 15, 2001 , 5:30 PM to 7:00 PM

Alexandre Ziegler, HEC-Lausanne

Game-Theory Analysis of Options

Many problems in game-theory have the property that (i) the strategic interactions considered take place in an uncertain environment and (ii) players have some timing flexibility. Analyzing such dynamic trading interactions under uncertainty using expected utility directly is often challenging. We show how option prices instead of expected utility can facilitate the analysis of deposit insurance. The analysis demonstrates that (i) deposit insurance need not induce banks to increase asset risk if asset value can be observed on a regular basis, but that (ii) such incentives will arise is asset value is unobservable. Using and incentive contract structure, we show that for purposes of reducing the expected cost of deposit insurance to the gurarantor, monitoring asset value and monitoring asset risk can be considered as substitutes.