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Journal for Studies in Management and Planning

Available at http://edupediapublications.org/journals/index.php/JSMaP/

e-ISSN: 2395-0463

Volume 02 Issue 2

February 2016

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 50

Finance Applications of Game Theory and Behavioral

Finance:A Review and Synthesis

Onuegbu Onyekachi ; Iwedi Marshal ; Igbanibo Dumini Solomon

1Department of Banking and Finance Michael Okpara University of Agriculture, Umudike

Abia State, Nigeria

2&3 Doctoral Students Department of Banking and Finance Rivers State University of Science

and Technology, Nkpolu Port Harcourt, Nigeria.

ABSTRACT

This paper briefly reviews and synthesizes

the finance applications of game theory

and behavioral finance. It demonstrated

how game theoretic techniques have

allowed insight into these puzzles with

higher order beliefs, informational

cascades and heterogeneous prior beliefs.

It has also helped in resolving the

apparent empirical anomalies in

traditional finance theories using the two

building blocks of behavioral finance.

Keywords: Finance, Game Theory,

Behavioral Finance, Limit to Arbitrage,

Psychology Bias

1. INTRODUCTION

Basically finance is concerned with how

the savings of investors are allocated

through financial markets and

intermediaries to firms, which use them to

fund their activities (Allen & Morris 1998

and Arias 2010). In broad term, finance

can be broken down into two domain of

knowledge. The Asset Pricing: This is

interested with the decisions of investors.

Corporate Finance: This deals with the

decisions of firms.

However, this paper will focus on

corporate finance domain of knowledge

and the finance application of game theory

with the view of unveiling certain

behaviors that are regularly witnessed. The

traditional finance theory/thinking relies

on assumptions of certainty, complete

knowledge and market efficiency and in

this context financial decisions are

relatively straight forward.

1.1 The Capital Assets Pricing Model

(CAPM)

In finance, the capital asset pricing model

(CAPM) is used to determine a

theoretically appropriate required rate of

return of an asset, if that asset is to be

added to an already well-diversities

portfolio, given the assets non- diversifiable risk. The model takes into

account the asset’s sensitivity to non- diversifiable risk (also known as

systematic risk or market risk), often