Backward Induction and Optimal Stopping Times in Financial Theory - Lecture 16

Explore the powerful concept of backward induction and its applications in financial theory and decision-making in this 1 hour 19 minute lecture from Yale University's Financial Theory course. Begin by learning how to quickly calculate implied default probabilities using a duality trick and interpret them as spreads in forward rates. Delve into the main topic of backward induction, a technique pioneered by mathematician Zermelo in the early 1900s to prove the existence of optimal strategies in chess. Examine its application in various optimal stopping problems, including examples from economics and everyday life such as deciding when to stop dating and get married. Discover how the option to continue in these scenarios often holds surprising value. The lecture covers calculating default probabilities, relating defaults to forward rates, understanding Zermelo's contribution to chess and backward induction, applying backward induction to optimal stopping games, and solving the optimal marriage problem.