Risk-neutral equilibria of noncooperative games

Robert Nau ()

Theory and Decision, 2015, vol. 78, issue 2, 188 pages

Abstract: Game-theoretic solution concepts such as Nash and Bayesian equilibrium start from an assumption that the players’ sets of possible payoffs, measured in units of von Neumann–Morgenstern utility, are common knowledge, and they go on to define rational behavior in terms of equilibrium strategy profiles that are either pure or independently randomized and which, in applications, are often taken to be uniquely determined or at least tightly constrained. A mechanism through which to obtain a common knowledge of payoff functions measured in units of utility (or common priors over predetermined sets of such functions) is not part of the model. This paper describes an operational method of constructing a state of common knowledge of the key parameters of the players’ utility functions in terms of conditional small bets on the game’s outcome. When the rationality criterion of joint coherence (no arbitrage) is applied in this setting, the solution of a game is typically characterized by a convex set of correlated equilibria. In the most general case, where players are risk averse, the parameters of the equilibria are risk-neutral probabilities, interpretable as products of subjective probabilities and relative marginal utilities for money, as in financial markets. Risk aversion generally enlarges the set of equilibria and may present opportunities for Pareto-improving modifications of the rules of the game. Copyright Springer Science+Business Media New York 2015

Keywords: Nash equilibrium; Correlated equilibrium; Coherent previsions; Subjective probabilities; Risk-neutral probabilities; Lower and upper probabilities; Asset pricing; Arbitrage; Matching pennies (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1007/s11238-013-9413-0

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