An Application of Game Theory: Cost Allocation

The allocation of operating costs among the lines of an insurance company is one of the toughest problems of accounting; it is first shown that most of the methods used by the accountants fail to satisfy some natural requirements. Next it is proved that a cost allocation problem is identical to the determination of the value of a cooperative game with transferable utilities, and a new accounting methods that originate from game theory are proposed. One of those methods, the proportional nucleus, is recommended, due to its properties. Several practical examples are discussed throughout the paper. Keywords: Game theory, cost allocation.