μ-σ Games

Risk aversion in game theory is usually modelled using expected utility, which has been critized early on leading to an extensive literature on generalized expected utility. In this paper we are first to apply μ-σ theory to the analysis of (static) games. μ-σ theory is widely accepted in the finance literature, using it allows us to study the effect on uncertainty endogenous to the game, i.e. mixed equilibria. In particular, we look at the case of linear μ-σ utility functions and determine the best response strategy. In the case of 2×2and N×M-games we are able to characterize all mixed equilibria. ∗School of Economics and Finance, Faculty of Business, Queensland University of Technology, GPO Box 2434 Brisbane, Qld 4001 Australia, E-mail: uwe.dulleck@qut.edu.au and Freie Universität Berlin, Chair of Banking and Finance, Boltzmannstr. 20, D-14195 Berlin, Germany, E-mail: AL@wacc.de. We thank Rudi Kerschbamer for many discussions during our work on the paper.