GameStop and the Prisoner's Dilemma - Sell or Hold?

Disclaimer: This post is not intended as legal, financial or investment advice and should not be construed or relied on as such. Before making any commitment of a legal or financial nature you should seek advice from a qualified and registered legal practitioner or financial or investment adviser.

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In all of game theory, there is perhaps no experiment more popular and more often retold than the prisoner’s dilemma.

Developed by Merrill Flood and Melvin Dresher at RAND Corporation in 1950, it poses the following problem:


Two members of a criminal gang are arrested and imprisoned. 

Each prisoner is in solitary confinement with no means of communicating with the other. 

The prosecutors lack sufficient evidence to convict the pair on the principal charge, but they have enough to convict both on a lesser charge. 

Simultaneously, the prosecutors offer each prisoner a bargain. Each prisoner is given the opportunity either to betray the other by testifying that the other committed the crime, or to cooperate with the other by remaining silent. 

The possible outcomes are:

  • If A and B each betray the other, each of them serves two years in prison
  • If A betrays B but B remains silent, A will be set free and B will serve three years in prison
  • If A remains silent but B betrays A, A will serve three years in prison and B will be set free
  • If A and B both remain silent, both of them will serve only one year in prison (on the lesser charge).

Prisoners will have no opportunity to reward or punish the other prisoner after the decision has been made.

 

The experiment has been used to highlight the bias humans display towards cooperative behaviour, rather than self-interested behaviour. 

If A and B truly have each other’s and their own best interests at heart - that of the collective - they should both remain silent, and suffer short one year sentences together. Anything other than this will result in longer sentences for one, or both of the prisoners.

The Gamestop Dilemma

The recent GameStop saga offers an opportunity to see this experiment play out at scale, on a global level.

The GameStop (or “Gamestonk!”) saga has marked the culmination of a long-brewing revolution that began on the r/wallstreetbets subreddit, pitting millions of everyday people against institutional hedge funds.
Shares of the brick and mortar videogame retailer, Gamestop (GME), had been identified as a heavily shorted stock (remarkably, more than 140% of the stock had been shorted by institutional investors...140%!), and as a result, it was  being targeted by the r/wallstreetbets community, with millions of retail traders taking up positions in the stock, and driving its price up from US$19.38 on Dec 29 2020 to an at-time-of-writing US$311 (and a high of US$492) on Jan 28 - a 25X increase in one month. 


The purpose of this run on GME shares appears to be three-fold:

  • Drive up the price and force a short squeeze, forcing institutional investors to buy back stock at higher prices, further driving up the price and costing hedge funds billions in the process (they have reportedly lost tens of billions already)
  • Make some quick money, at the expense of the ‘Wall Street elite’
  • Force systemic changes in the financial system towards a fairer and less corrupt reality


For those with vivid memories of how the global economy went into meltdown in 2008, and all of the deleterious downstream effects this had on everyday people - job losses, property price crashes, mortgage foreclosures, and so on - the run on GME has presented many with what they perceive as an opportunity for payback. Indeed, one redditor posted a heartfelt recollection of the effect the 2008 global financial crisis had on their family. 

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Sell or Hold? Snitch or Silence?

In the Gamestop dilemma, there is uncertainty around what other members of the community will actually do, particularly as prices demonstrate volatility, and tumble - often on the back of what pundits anticipate is hedge fund induced manipulation. Will people lose their nerve and sell? Selling will affect supply and demand, and put downwards pressure on the price. Holding (and buying) will do the opposite.

Robinhood, the online brokerage platform that has been accused of manipulating the market by blocking retail traders from buying, but not selling, stocks such as GME on Jan 28 (as well as AMC, NAKD and others), has buckled under pressure thanks to the ensuing backlash from both sides of the political divide, It has announced that limited trading will now be available for these stocks. 

As a result, after hours trading on GME on Jan 28 has seen the stock soar by 50%, up to a peak of US$311. This, and the fact that r/wallstreetbets members have 17 hours to find alternative platforms to trade from, should give r/wallstreebets members confidence to both buy and hold.

With all of this in mind, if the r/wallstreetbets community really is about sticking it to the proverbial man, and benefiting each other in the process, then they - like the two prisoners - should not sell (in place of snitch) and instead hold (in place of silence) until a mass sell-off of retail positions begins - one that isn’t influenced by panic buying or market manipulation. Just when such a sell-off might occur is not entirely clear, but it may be triggered by a significant decrease in the short positions of GME, which currently stands at a whopping 120%, or the achievement of a US$1,000 share price.

The alternative of course is to dump stock early to lock in profits or limit current losses, drive prices down, incur losses for other members of the r/wallstreetbets community left holding the hot potato - and at the same time, helping hedge funds cover their short positions. This ultimately compromises the objectives of the run on GMC somewhat. 

Final Thoughts

What coming days will represent is a unique glimpse into the psyche of the collective human spirit, as millions of strangers around the world show us whether they do indeed display an overwhelming tendency towards cooperative behaviour or not. 

If nothing else, as Kollen Post wrote, the market chaos seems to have drawn enough attention to merit a sea change in securities laws as they apply separately to retail and institutional investors. 

And if this leads to substantive change, it is a victory. 

Posted 
January 29, 2021
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