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The Amazing Race
Principal Agent Problems in the Financial Crisis of 2007-2009

BMI Master Thesis

November 2009

Jasper Holke Klein
Supervisor: Rob van der Mei

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Faculty of Sciences Business Mathematics and Informatics De Boelelaan 1081a 1081 HV Amsterdam
Preface

This paper is one of the last compulsory elements of the program Business Mathematics and Informatics at the VU University Amsterdam. The objective of this subject is to demonstrate the student 's ability to describe a problem in a clear manner for the benefit of an expert manager. This is accomplished by doing a literature research and to apply this research to a practical situation.
I have always had a strong interest in strategic thinking. One of the ways that this is modeled in the scientific theory is through game theory. From the broad range of subjects that are available in game theory I decided to focus on information asymmetry and, more specifically, on the principal-agent relationship as this theory is very widely applicable and has a strong explanatory power. In this way I was able to combine my interest in strategic thinking and the financial sector and able to give a clear explanation for the events that happened within the financial crisis of 2007 - 2009.
Finally, I would like to thank my supervisor Rob van der Mei for his comments and suggestions.

Amsterdam,
November 2009,
Jasper Holke Klein
Summary
This paper analyses the origin of the financial crisis from a game theoretic perspective. We use the principal-agent theory as a basis for our analysis. Principal-agent theory is broadly applicable in situations where multiple parties strive to maximize their utility and which have asymmetric information.
The financial crisis started after the bust of the US housing bubble, which originated as a result of irresponsible profit maximization by parties in the mortgage lending chain. Those parties couldn’t be held accountable for


Bibliography: [1] Ashcraft, Schuermann (2008): Understanding the Securitization of Subprime Mortgage Credit (Federal Reserve Bank of New York) [2] Blackburn, R [3] Blundell, M. (2009): Principal Agent Problem [4] Brandenburger, A [5] Chiappori, P.-A. (2000): Econometric Models of Insurance under Asymmetric Information [6] Dixit, Nalebuff (1991): Thinking strategically (ISBN: 0-393-31035-3) [7] Haldane, A. G.(2009): Why banks failed the stress test (Bank of England) [8] Hull, J [9] International Energy Agency (2007): Mind the Gap [10] Laffont, Martimort (2002): The theory of Incentives (ISBN: 0-691-09183-8) [11] Myerson, R. B. (1991): Game Theory: Analysis of conflict (ISBN: 0-674-34116-3) [12] Stanford Encyclopedia of philosophy (Stanford University, Stanford USA) [13] Watson, J. (2002): Strategy, An Introduction to Game Theory (ISBN: 0-393-97648-3)
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