Ideas with Impact
UNB Faculty of Management

A Game Theory Approach to Maximizing Profits and Minimizing Risks

Author: Faculty of Management

Posted on Nov 16, 2023

Category: Alumni , Research , Faculty

On the trading floor, the process of executing buy or sell orders is a crucial part of the financial world. Whether it's done manually or electronically, it's not always an immediate transaction. Even minor delays can impact the cost of the stocks you're buying or selling, especially when dealing with substantial orders. This is where the research of UNB business professor Dr. Donglei Du comes into play.

In his recent research paper, published in the Annals of Operations Research (2022), Dr. Du delves into the world of executing large orders more effectively by applying game theory principles developed by the economist Heinrich von Stackelberg. This innovative approach aims to optimize trading strategies and minimize risks, particularly in scenarios involving significant transactions.

Dr. Du's study revolves around a situation commonly encountered in financial markets when algorithms are at play. It involves two key players: the leaders and the followers. These individuals are all seeking to maximize their profits by trading a single, volatile asset within a specific time frame.

The dynamics of this trading environment involve not only the leaders but also the followers, who closely monitor the leaders' activities in the market. When large orders are pending, these followers, known as "arbitrageurs" in game theory, swiftly enter the scene to capitalize on the situation. Their actions can significantly influence the outcome of the deal, adding an additional layer of complexity to the trading process.

Regulators have long sought ways to prevent arbitrageurs from taking advantage of large traders. While it's illegal for arbitrageurs to exploit private data, it becomes challenging to regulate their actions when they are operating based on publicly available information.

Dr. Du's research offers valuable insights and recommendations to leaders operating in such scenarios. For example, instead of executing large transactions all at once, the study suggests breaking them down into smaller chunks. This approach helps lower the risk of losing out to opportunistic arbitrageurs.

Dr. Du's work in this area contributes to a deeper understanding of how various market participants behave. It introduces innovative strategies for trading, particularly with the use of computer algorithms, which can enhance investment practices. Moreover, the research sheds light on the intricate structure of financial markets, paving the way for the development of more effective rules and regulations to ensure fairness and efficiency. Lastly, it provides a solid foundation for future studies on the execution of orders, considering the ever-changing dynamics of the market.

Photo: In his recent publication, Dr. Donglei Du delves into the world of executing large orders more effectively by applying game theory principles developed by the economist Stackelberg.

Learn more about Dr. Donglei Du’s research and about UNB’s faculty of management.

Media contact: Liz Lemon-Mitchell.