Ben Hunt: Investing Lessons from the Poker Table

February 3, 2015

by Justin Kermond

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Markets have not been this dominated by political uncertainty and divorced from economic fundamentals since the 1930s. Ben Hunt – Harvard Ph.D., the author of the Epsilon Theory Newsletter, and Chief Risk Officer at Salient Partners, an asset manager based in Houston, TX – provides useful lessons from game theory for thriving in what he calls “the age of central bankers.”

In a recent meeting of the Boston Security Analysts Society (BSAS), Hunt gave an impassioned overview of the application of game theory to markets to evaluate investment decisions under uncertainty.

Game theory in Poker and the Game of Thrones

Hunt introduced game theory in the context of poker. To be successful, one needs to play the player and not the cards. Having been dealt the same cards, an intelligent player will make different decisions playing against a table of off-duty Las Vegas card dealers than he would against a table of “half-inebriated dentists,” Hunt said. Thinking about the cards as the fundamentals of investments, the player should focus on the other market participants along with their strategies and incentives. Hunt offered the old adage, “If you have been playing cards for 30 minutes and you don’t know who the sucker is, it is you.” Hunt said this is true in markets as well. An understanding of game theory, along with an understanding of the players and games that are played in the markets, will help investors avoid being that sucker.

The central concept of game theory is strategic interaction while making decisions under uncertainty, Hunt said. Decisions are not made in a vacuum, but in the context of other players also making decisions to advance. To illustrate the spectrum of risk, Hunt quoted former Secretary of Defense Donald Rumsfeld’s infamous statement regarding the lack of evidence linking the Iraqi government with the supply of weapons of mass destruction to terrorist groups in 2002:

“There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know.”

In the spectrum of risk, certainty includes the “known knowns,” risk includes the “known unknowns,” and uncertainty includes the “unknown unknowns.” All modern economic theory is based on decision-making under risk where potential outcomes can be identified with probabilities assigned.  With regard to investment decisions in the current environment characterized by central bank interventions, Hunt said that the use of “econometrics is not wrong, but is less useful in an environment of uncertainty than it is in an environment of risk.” Given the high degree of uncertainty, the lessons learned from game theory and history provide additional insights for success in today’s markets.

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