Stock Plunges, a Study in Game Theory
On Wednesday August 5th, 2015, Disney’s stocks plummeted a shocking 9 percent – the worst drop in the last four years. The drop stemmed from an announcement of losses in ESPN subscribers, an integral part of the Disney Company. Following the statement, many prominent economic analysts began doubting the security of TV-subscriber based profit models – though the CEO of Disney held fast that “it is very bullish.”
This idea of bull and bear markets, along with the behavior of stocks, is best illustrated using game theory. In a bull market, investors expect a profit from their shares in a company. Buying is high while selling is low. Disney so far this year has been in a bull market (stock up almost 20% this year). So the game for investors was similar to this set up: (an extremely simplified version, where one investors buys the stock sold by the other, and two stocks being available on the market).
| Investor A/ Investor B | Buy | Sell |
| Buy | +1/+1 | +3/0 |
| Sell | 0/+3 | 0/0 |
Clearly, given a high expectation of profit, both have “Buy” as their dominant strategy. So the equilibrium becomes that both investors buy, stock prices increase, and the market remains bullish.
With the announcement, Disney instilled doubt into the market for future profitability. According to analysts, there was reasonable expectation of losses due to “chord cutting”. With the difference in expected payoff, the game for investors changed to:
| Investor A/ Investor B | Buy | Sell |
| Buy | -1/-1 | -3/0 |
| Sell | 0/-3 | 0/0 |
Again, both have dominant strategies, to sell. This change in expectation of profit caused by market speculation altered the investment game, and caused a significant drop in stock prices.
Some might ask: why didn’t everybody sell given that that was the dominant strategy? First of all, the game only included active investors, it did not include the option “Stay” which is crucial for any overall stock game. Second, the announcement did not change some people’s expectation for profit. Finally, the game includes millions of other factors and systems which are not taught in introductory Networks classes.
http://money.cnn.com/2015/08/05/media/disney-stock-down-espn/
http://money.cnn.com/2015/08/20/media/media-stock-drop-disney/