Strategic Games in Asian Financial

Crises: the Case of Hong Kong

Presented by Hui Wang
Paper prepared by Heping Pan, Shan Wu, Honglei Zhang , Jiaqing Dai, Hui Wang
Chinese Institute of Intelligent Finance
Prediction Research Centre
University of Electronic Science & Technology of China
Phone: +86-28-83208708/83202290
Fax: +86-28-83207216
Email: wush2@swingtum.com
URL: http://www.mgmt.uestc.edu.cn/prc

Contents:
1. Introduction from Economic Finance and Behavioral
Finance to Strategic Finance

2. Asian Financial Crisis: the Case of Hong Kong

3. An Incomplete-Information Zero-Sum Game
of Three Camps Speculators, Government, and Masses
4. Hang Seng Index as the Battlefield
5. Scenario Tree Analysis of Strategic Game
6. Conclusions

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1. Introduction
Strategic
Finance
Behavioral
Finance
Economic Finance

2. Asian Financial Crisis

July 2 - Thailand announces a managed float of the baht. The
Philippines intervenes to defend its peso.
July 24 - Asian currencies fall dramatically. The Malaysian ringgit
was attacked by speculators.
Aug 13-14 - The Indonesian rupiah comes under severe
pressure.
Oct 20-23 - The Hong Kong dollar comes under speculative
attack; The Hong Kong stock market drops.
Oct 28 - The value of the Korean won drops as investors sell
Korean stocks.
Nov 3-24 - Japanese brokerage firm, largest securities firm
(Yamaichi Securities), and 10 largest bank (Hokkaido Takushoku)
collapse.
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The Case of Hong Kong

In 1997, Asian miracle turned to be a disaster. Since Thailand
decided to float its currency baht in July, it sent other Asian
currencies under attacking.
Hong Kong was not immune to the regional nightmare. The first
attack on the Hong Kong dollar began on October 23, 1997. As
the crisis in Asia developed into a worse situation, the impact on
Hong Kong deepened. Hong Kong's stock market dropped
significantly as speculators started three more attacks in 1998.
Faced with the worsening economy, on 14 August, 1998 the
Government changed from being a passive regulator to an
active market participant by accumulating large positions in local
blue chip stocks, and hostilities ended with the closing of the
August Hang Seng Index futures contract.
In 1999, the Government started selling those shares by
launching the Tracker fund of Hong Kong making a profit of
about HK$30 billion (US$4 billion).
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3. An Incomplete-Information Zero-Sum
Game of Three Camps
Three Camps: International strategic speculators (S)
Domestic government agencies (G)
Herding masses (M)
An Incomplete-Information Zero-Sum Game:
Incomplete-Information Game:
In this game, the three camps, or at least some of them
may lack full information about the other camps (or even
their own) payoff functions, about the physical or the social
resources or about the strategies available to others (or
even to them), or about the amount of information the
others have about various aspects of the game, and so on.
Zero-Sum Game:
Zero-sum describes a situation in which a participant's gain
or loss is exactly balanced by the losses or gains of the
other participants. If the total gains of the participants are
added up, and the total losses are subtracted, they will sum
to zero. Here, the loss and gain of S is equal to the gain or
loss of G and M.

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A Major Strategy of Speculators

Making a feint to the east

One of Thirty-Six Stratagems and attacking in the west
Attacking HKD as a catalyst trigger to prick the bubble

HKD

Interest
rates

HSI

Short HSI
futures
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Major Strategy of Government

Second Stage

First Stage

S and M short HSI

and HSI futures

HKD
Passive
reaction

Proactive
reaction

Raise interest rates

Buy index shares

Maintain the peg

system

HSI

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Pull HSI up 1169 points,

an increase of 17.55%,
and raise HSI futures.

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Objectives, Constraints and Capabilities

Objectives:
S: To obtain profits from short selling stock index futures
G: To defend its currency, equalize interest rates to break the speculative
cycle and remove incentives of speculators.
Constraints:
S: Risk control
Limited capital
Affected by herding behavior
G: Worries about damages to its image and reputation as the freest
economy

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Capabilities:
G: More than 860 billion US dollars foreign exchange reserves,
the third largest in the world.
Worlds perfect financial regulatory system
Healthy economy
Great confidence in HK dollar
Chinese government as a strong backup
S: Attacks on Hong Kongs peg system
Large flow of hot money (short-term bank deposits and short-term
securities with good liquidity)
Promotion of market herding effect, attracting large number of
investment funds to follow

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Speculators
Objective:
S. T.

R is profit. A is wealth. C is capital. t is the time scale. MV is the value of HKD. FV is

the value of HSI futures. is the quantity of HKD and HSI futures. P is the price of
HKD and HSI futures. f is the cost ratio.
is the exchange rate. N is the profit of one
pip. HSIF is the price of HSI futures. HSI is the price of HSI stocks.

Government
Objective:
S. T.

4. Hang Seng Index as the Battlefield

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5. Scenario Tree Analysis of Strategic Game

97.10.23 S short the HK$
and Hang Seng Index
Futures.

97.7 S took short

positions on the HK$
and Hang Seng Index
Futures.

G bought HK$
and raised interest
rates.

The linked exchange

rate maintained. HSI
fell.

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98.6.12 S took short

positions on the HK$
and Hang Seng Index
Futures.

G bought HK$
and raised interest
rates.

The linked exchange

rate maintained. HSI
fell.

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98.8.5 S took short

positions on the HK$
and Hang Seng
Index Futures.

G actively bought
HK$ and raised
interest rates.

The linked exchange

rate maintained. HSI
fell.

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98.8.13 S took short

positions on the HK$
and Hang Seng Index
Futures.

98.8.14 S took short

positions on the HK$
and Hang Seng
Index Futures.

G bought HK$
and put it back to
the banking
system to maintain
interest rates.

G used exchange
fund and land
fund to buy bluechip shares of the
HSI and to raise
the index futures.

98.8.24 G used 50
billion HK dollars
to intervene in the
market.

HSI redounded 560

points and closed at
7224 points.

HSI surged 317 points

and closed at 7845
points.

The linked exchange

rate maintained. HSI
fell.

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98.8.25 S closed the

August HSIF and
short sell the
September HSIF

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G intervened in
the market and
raised the
September
index futures.

The linked exchange

rate maintained. HSI
rose.
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98.8.28 S sold off

blue chips and large
European fund
entered the market.

98.8.26 G actively
short HSIF, and
speculators followed
the trend.

S took short
positions on the HK$
and Hang Seng
Index Futures.

98.8.27 G spent
200 billion HK
dollars.

HSI plunged 160

points and then went
back to its original
level.

HSI closed at 7922

points and rose 88
points.

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G still intervened in
the market, and
pulled HSI up 1169
points, an increase
of 17.55%.

98.9.5 G unveiled
seven new
monetary
measures to
strengthen the peg
system and to ease
extreme volatility
of interbank rates.

HSI finally closed at

7829 points, and HSIF
settled at 7851 points.

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6. Conclusions
Hong Kong provides the first case of its kind in the history of
modern financial markets in the sense that it was the first time
an explicit strategic game was played speculators, government
agencies and masses.
The complexity of this strategic game is so overwhelming that
we must combine game-theoretical reasoning, macroeconomic
analysis and behavioural dynamics of financial markets in a
retrospective analysis.
The game-theoretical analysis starts with a clarification of the
initial situations of the major players and their objectives,
capabilities and constraints. It then proceeds to generating
multi-stage game scenario trees. Wins or losses of each camp at
each stage are evaluated, and consequences and lessons are
discussed.
This research reminds us that strategic finance may emerge as
a new level of understanding on top of economic finance and
behavioural finance.
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Thanks for your attention!

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