Mechanism Design Theory in Control Engineering: A Tutorial and Overview of Applications in Communication, Power Grid, Transportation, and Security Systems

This article provides an introduction to the theory of mechanism design and its application to engineering problems. Our aim is to provide the fundamental principles of the theory of mechanism design for control engineers and theorists along with the state-of-the-art methods in engineering applications. We start our exposition with a brief overview of game theory highlighting the key notions that are necessary to introduce mechanism design, and then we offer a comprehensive discussion of the principles in mechanism design. Finally, we explore four key applications of mechanism design in engineering, i.e., communication networks, power grids, transportation, and security systems

Incentive Mechanisms for Managing and Controlling Cyber Risks: The Role of Cyber Insurance and Resource Pooling

Faced with a myriad of costly and frequent cyber threats, organizations not only invest in software security mechanisms such as firewalls and intrusion detection systems but increasingly also turn to cyber insurance which has emerged as an accepted risk mitigation mechanism and allows purchasers of insurance policies to transfer their risks to the insurer. Insurance is fundamentally a method of risk transfer, which in general does not reduce the overall risk and may provide disincentives for firms to strengthen their security; an insured may lower its effort after purchasing coverage, a phenomenon known as moral hazard. As cyber insurance is a common method for cyber risk management, it is critical to be able to use cyber insurance as both a risk transfer mechanism and an incentive mechanism for firms to increase their security efforts. This is the central focus and main goal of this dissertation. Specifically, we consider two features of cybersecurity and their impact on the subsequent insurance contract design problem. The first is the interdependent nature of cybersecurity, whereby one entity's state of security depends not only on its own effort but also on the effort of others in the same eco-system (e.g., vendors and suppliers). The second is our ability to perform an accurate quantitative assessment of security posture at a firm-level by combining recent advances in Internet measurement and machine learning techniques. The first feature, i.e., the risk interdependence among firms is an interesting aspect that makes this contract problem different from what is typically seen in the literature: how should policies be designed for firms with dependent risk relationships? We show security interdependence leads to a profit opportunity for the insurer, created by the inefficient effort levels exerted by the insureds who do not account for risk externalities when insurance is not available. Security pre-screening then enables effective premium discrimination: firms with better security conditions may get a discount on their premium payment. This type of contract allows the insurer to take advantage of the profit opportunity by incentivizing insureds to increase their security effort and improve the state of network security. We show this conclusion holds even when an insurer has the ability to seek loss recovery when an incident can be attributed to a third party. By embedding these concepts in a practical rate-schedule based underwriting framework we show that these results can be readily implemented in existing practice. While pre-screening is an effective method to incentivize effort, the insureds may lower their efforts after the pre-screening and post-contract, within the policy period, in yet another manifestation of moral hazard. We show that this can be mitigated through periodic screening combined with premium adjustment, effectively resulting in an active policy that has built-in contingencies, and the actual premium payable is realized over time based on the screening results. Outside the context of insurance, the study of inefficient security investment and how to design incentives is commonly formulated as an interdependent security game. In a departure from typical taxation and subsidy based mechanisms, we consider resource pooling as a way to incentivize effort in a network of interdependent agents, by allowing agents to invest in themselves as well as in other agents. We show that the interaction of strategic and selfish agents under resource pooling improves the agents' efforts as well as their utilities.PHDElectrical and Computer EngineeringUniversity of Michigan, Horace H. Rackham School of Graduate Studieshttps://deepblue.lib.umich.edu/bitstream/2027.42/155236/1/khalili_1.pd