Vol 21 – Game Theory: The Politician's Dilemma
- Ann Yu
- Apr 20
- 8 min read
April 20, 2025
Last week, a client asked me, "How do you decide what topics to cover in the newsletter? Did you use ChatGPT?"
Well, AI chatbots are great for gathering data and polishing my less-than-perfect English. But when it comes to picking topics - that’s all me. From Monday to Friday, I read as much as I can, and by the time the weekend rolls around, the ideas that stick will make it to the newsletter.
We don’t have a huge reader base (honestly, it's quite small😆), but to me, this newsletter is more of a personal reflection - a way to document my thoughts and to set a role-model for my son about the power of persistence, even when no one is watching/reading.
What’s in this week’s newsletter?
This weekend, 3 ideas really stuck with me:
1️⃣ Game Theory Meets Tariffs: Prisoner's Dilemma & Trembling Hands: How might these old concepts from textbooks help us untangle the chaotic tariff situation? Is there a rational explanation behind Trump's irrational behavior?
2️⃣ Reimagine the Endowment Model: Neuberger Berman’s latest report takes a fresh look at the highly sought-after Endowment Portfolio Model. How does the historical performance compare with a traditional 70/30 Equity/Bond portfolio?
3️⃣ Is China Dumping US Treasury Holdings? This hot topic has been on many clients’ minds. Let’s dive into the numbers to see if they can provide clarity (or raise more questions).
Category | Contents for this week |
|---|---|
1) Dilemma of the Week | |
2) Market Buzz | |
3) Fun Facts |
Key things to watch for the upcoming week:
China/HK - Earnings | Apr 25 (Fri) - Ping An (2318 HK) |
US - Earnings | Apr 22 (Tue) - Tesla (TSLA), Intuitive Surgical (ISRG) Apr 24 (Thu) - Alphabet (GOOGL) |
US – Eco Data | Apr 23 (Wed) - US April Manufacturing PMI and Services PMI |
Dilemma of the Week – Game Theory Meets Tariffs: Prisoner's Dilemma & Trembling Hands
A classic problem in game theory that many of us learned in school is The Prisoner's Dilemma. It presents a situation where two rational individuals might make decisions that lead to worse outcomes for both. Scenario
Imagine two suspects, Adam and Ben, who have been arrested and interrogated separately. The authorities have no other witnesses and can only convict them if at least one betrays the other and confess.
Possible Outcomes
Both remain silent → Each gets a light sentence, say 1 year of jail time, because there isn't enough evidence.
One confesses, the other stays silent → The confessor goes free while the silent one gets a harsher sentence, say 5 years in jail.
Both confess → Each receives 3 years for partial cooperation.
The Dilemma
The trick is this: if you were Adam, regardless of what Ben does, your best strategy would always be to betray him and confess. Why?
If Ben confesses, you should confess too - reducing your sentence from 5 years (if you remain silent) to 3 years (if both confess).
If Ben stays silent, confessing is still your best move - you not only dodge the 1-year sentence (if both stay silent), but you walk away free while Ben takes the fall (since Ben would be the only one silent).
The Irony Since both Adam and Ben are rational and aim to minimize their jail time, both will have the incentive to betray and confess, leading to 3 years each (6 years total). This is called the Nash Equilibrium, named after mathematician John Nash.
However, this is clearly NOT the best solution. If they had cooperated and remained silent, they would have gotten a better outcome - only 1 year each (2 years total).
This highlights the paradox of game theory: while self-interest drives their choices, it leads to a collectively worse result. The Tariffs Sharp readers will see where this is headed.
If we replace Adam and Ben with two countries, and swap the decision of confessing or remaining silent with the choice to implement tariffs or not, the dynamics remain the same.
Even if the leaders of both nations are rational, each will still have an incentive to impose tariffs, anticipating that the other will do the same.
As a result, despite the fact that mutual cooperation (avoiding tariffs) would lead to a better overall economic outcome, both will ultimately choose to implement tariffs, reinforcing the dilemma.
Breaking the Dilemma: Possible Solutions History is full of instances where the Prisoner’s Dilemma has disguised itself as tariff negotiations. Luckily, humans have devised ways to escape this trap over the years:
1. The Power of Repeated Games - Tit for Tat!
Unlike the original prisoner scenario, where each suspect faces a one-time decision, trade negotiations happen over multiple rounds. This opens the door for smarter strategies.
For example, start with cooperation - No Tariffs - but make it crystal clear that retaliation will come if the other country dares to impose tariffs first.
By setting expectations upfront, both countries prioritize stability and stay in the collectively optimal outcome, avoiding unnecessary trade wars.
2. Community of Interests
Establishing global power squads like the World Trade Organization, European Union, and the late NAFTA to keep everyone in check while slapping fines on troublemakers.
The Trembling Hand Equilibrium
But we will be too naive to believe above model alone can solve the trade war mess we're facing today.
So if you're still with me, let's move on to the next level. Now, imagine the prisoners are old and rusty and they have to account for the possibility that the other prisoner might make mistakes - like his trembling hands accidentally pressing the wrong button or miscalculating their moves. Suddenly, the stakes shift.
Prisoners assume opponents might occasionally make errors.
Strategies must remain optimal even with small mistakes.
The Cold War in actual history showcased this: The U.S. warned the Soviets: Touch West Berlin, and nuclear war follows. The Soviets fired back with the same threat.
Logically, launching nukes over an already-seized city seemed irrational. But the Soviets feared President Reagan’s "trembling hands" - whether literal or strategic - might still press that nuclear button without fully weighing the consequences.
Mastering the "Crazy" Negotiation Tactic Sometimes, appearing unpredictable and irrational makes threats more credible.
If opponents believe you might act impulsively, they take warnings seriously.
An article in Taiwan's CommonWealth Magazine this week outlined three key points when using calculated irrationality in negotiations:
Unshakable conviction – Make your demands seem so unwavering that even unreasonable requests appear normal coming from you.
Controlled chaos – Provoke your opponent, but keep them rational enough to engage. You will need a rational opponent to win the game.
Clear stakes – Spell out the benefits of agreeing and the costs of refusal. Make it easier for the rational opponent to decide.
The paradox? The more logical your opponent, the less advantage he/she has dealing with the crazy you.
Take Trump - his tactics so far largely align with this approach, except in dealings with China, where he violated rule two by potentially unsettling the opponent too much.
Negotiation isn’t just about logic - it’s also about psychology and control. The Prisoner’s Dilemma shows the pitfalls of self-interest, while Trembling Hand Theory proves that even a hint of unpredictability can shape decisions differently.
For your reference only. Not investment/product recommendations.
Market Buzz – Reimagine the Endowment Model
The Endowment Model of investing, pioneered in the 1980s at Yale University, was an evolution of traditional diversified investment portfolios. With a perpetual time horizon and minimal liquidity needs, the model emphasizes diversification and chases high return potentials by investing in hedge funds, venture capital and growth-focused private equity funds. This is a highly sought-after model in recent years, especially for family offices who also enjoys long time horizon and limited cash needs. In fact, many clients I’ve spoken to are adamant - they want their wealth managed the "Endowment way." But here’s the kicker: over the last decade, endowments have only managed to keep pace with a simple 70/30 Equity/Bond portfolio - and in 2023 and 2024, they fell behind.
According to a recent report from Neuberger Berman, two major factors have weighed down endowment performance:
Over-reliance on venture capital and private equity: Over the past 20 years, endowments have ramped up their allocations to venture capital (from 3.5% to 12.4%) and private equity (from 4.9% to 17.3%). However, as fund sizes ballooned, returns became diluted (don't forget the fees!). Adding to the struggle, COVID-era disruptions threw cash flow timing into chaos, triggering over-investment in 2020 and 2021 - only to leave endowments cash-strapped when the 2022 market downturn created prime investment opportunities.
Too many cooks: Diversifying across fund managers should reduce risk, but that only works when managers actually take different approaches. For example, many fund managers opted to steer clear of the pricey Mag7 stocks last year, leaving endowments underexposed to one of the strongest investment themes in recent history.
In case you're wondering, no, we don't think the Endowment model is broken. It just needs to be "reimagined". Check out the original report or skip the research and chat with Jadewell Family Office directly instead!
For your reference only. Not investment/product recommendations.
Fun Facts - How Big is China's Holding of US Treasuries?
Earlier this week, fresh data revealed that China increased its US Treasury holdings in February 2025 to $784 billion, still the second-largest foreign creditor after Japan. Sounds like a lot, right? But here’s the reality check: that sum makes up less than 3% of the entire US Treasury market and doesn’t even match the daily trading volume of $900 billion.
So, the idea that China could shake things up by dumping its US debt? Not quite the financial earthquake some imagine.
But here’s the real mystery - China has offloaded around $630 billion in US Treasuries over the past decade. Where did all that cash end up?
About Jadewell Family Office
Jadewell is committed to offering proactive, customized services akin to a “single-family office,” yet within the ease of a “multi-family office” environment.
Ann Yu
Co-Founder and CEO
Jadewell Family Office
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