Game Theory models how "rational" actors make decisions when their success depends on the choices of others. The US-Iran dynamic can be analysed via three specific models.
First, there is the Game of Chicken. The tensions around the Strait of Hormuz resemble brinkmanship: the US uses naval pressure, while Iran threatens disruption. Both sides want the other to back down, but neither can do so easily without appearing weak. The danger is that both must act as though they are willing to risk the worst-case outcome - war or a major energy shock - to make their threats credible.
Second, this is also an Asymmetric Escalation game. Iran uses relatively cheap tools such as drones, mines, and proxies to impose disproportionately high costs. The US, by contrast, relies on its structural advantages - especially military power and the global financial system - to squeeze Iran and test whether it will hold out or negotiate. So, while both are escalating, they are doing so in very different ways.
Third, the conflict is shaped by signalling and credibility. In game theory, threats only matter if they are believable. US military deployments signal commitment through sunk costs (though the TACO trade has undermined Trump’s credibility), while Iran’s harder-to-reverse actions, such as expanding uranium enrichment, signal that backing down is politically and strategically costly.
This helps explain the current deadlock. Both sides are effectively stuck in a Nash equilibrium: neither can improve its position by changing strategy alone. If the US eases pressure without concessions, it looks weak; if Iran de-escalates without sanctions relief, it loses leverage. Elsewhere, if the US follows through on its earlier threat to destroy Iran’s power infrastructure the equilibrium will clearly be broken, causing a shift to a higher escalation game, an increase in the probability of multi-theatre conflict, whilst making a negotiated off-ramp harder because both sides’ domestic politics and credibility constraints tighten.
As a result, it’s likely that the standoff continues until some external shock - diplomatic change, domestic politics, or accidental escalation - forces both sides to recalculate.
Against this highly uncertain (and unsatisfactory) background, thanks to a knockout corporate earnings season, equities, particularly in the US, have remarkably remained resilient.
Capital at risk. All views expressed are those of the author and should not be considered a recommendation or solicitation to buy or sell any products or securities.
