A new, evolutionary explanation of markets and investor behavior
Half of all Americans have money in the stock market, yet economists can't agree on whether investors and markets are rational and efficient, as modern financial theory assumes, or irrational and inefficient, as behavioral economists believe—and as financial bubbles, crashes, and crises suggest. This is one of the biggest debates in economics and the value or futility of investment management and financial regulation hang on the outcome. In this groundbreaking book, Andrew Lo cuts through this debate with a new framework, the Adaptive Markets Hypothesis, in which rationality and irrationality coexist.
Drawing on psychology, evolutionary biology, neuroscience, artificial intelligence, and other fields, Adaptive Markets shows that the theory of market efficiency isn't wrong but merely incomplete. When markets are unstable, investors react instinctively, creating inefficiencies for others to exploit. Lo's new paradigm explains how financial evolution shapes behavior and markets at the speed of thought—a fact revealed by swings between stability and crisis, profit and loss, and innovation and regulation.
A fascinating intellectual journey filled with compelling stories, Adaptive Markets starts with the origins of market efficiency and its failures, turns to the foundations of investor behavior, and concludes with practical implications—including how hedge funds have become the Galápagos Islands of finance, what really happened in the 2008 meltdown, and how we might avoid future crises.
An ambitious new answer to fundamental questions in economics, Adaptive Markets is essential reading for anyone who wants to know how markets really work.
Andrew W. Lo is the Charles E. and Susan T. Harris Professor at the MIT Sloan School of Management and director of the MIT Laboratory for Financial Engineering. He is the author of Hedge Funds and the coauthor of A Non-Random Walk Down Wall Street and The Econometrics of Financial Markets (all Princeton). He is also the founder of AlphaSimplex Group, a quantitative investment management company based in Cambridge, Massachusetts.
"Mr. Lo makes a convincing argument and he also uses the book to lay out some interesting ideas--such as a huge, diversified fund that would invest in a range of potential cancer treatments."--Economist
"[A] remarkable new book. . . . Lo’s book will be read and read widely. . . . His insights should allow investors and regulators alike to manage risks better. They should read it."--John Authers, Financial Times
"This new book will become another essential read for anybody interested in financial markets. . . . [It] is a thoroughly interesting and enjoyable read. It is not technical, the explanations are super-clear, and there is some excellent story telling."--Enlightened Economist
"[Lo] has a knack for providing a telling anecdote or story to illustrate his point. More important, he also avoids being condescending or triumphalist."--Matthew Partridge, Money Week
"Using research in evolutionary biology, psychology, neuroscience and artificial intelligence, Mr. Lo . . . explains how human behavior shapes the markets, leading to swings between stability and instability, profit and loss, innovation and regulation."--Pensions & Investments
"Andrew Lo’s Adaptive Markets is a masterly synthesis of the traditional, rationality-based approach and new approaches based on psychology and neuroscience, evolutionary theory, and techniques such as computer simulations and artificial intelligence."--Diane Coyle, Project Syndicate
"Andrew Lo’s ambitious book offers a welcome, fresh look at how financial markets work and why they sometimes fail. . . . Adaptive Markets makes a valuable and welcome contribution, rewarding the reader by broadening and improving our understanding of finance and markets--in stable and unstable times."--Milton Ezrati, City Journal
Table of Contents
Other Princeton books authored or coauthored by Andrew W. Lo: