Adaptive Markets and the New World Order
Andrew W. Lo
December 30, 2011

Massachusetts Institute of Technology (MIT) – Sloan School of Management ; Massachusetts Institute of Technology (MIT) – Computer Science and Artificial Intelligence Laboratory (CSAIL) ; National Bureau of Economic Research (NBER)

Abstract: The traditional investment paradigm is based on several key assumptions including rational investors, stationary probability laws, and a positive linear relationship between risk and expected return with parameters that are constant over time and which can be accurately estimated. These assumptions were plausible during the “Great Modulation” — the seven decades spanning the mid-1930s to the mid-2000s in which equity markets exhibited relatively stable risk and expected returns — but have broken down during the past decade, implying temporary but significant violations of rational pricing relationships. This tension between rational and behavioral market conditions is captured by the Adaptive Markets Hypothesis (AMH), an evolutionary perspective on market dynamics in which intelligent but fallible investors learn from and adapt to changing environments. Under the AMH, markets are not always efficient, but they are highly competitive and adaptive, and can vary in their degree of efficiency as the economic environment and investor population change over time. The AMH has several new implications for financial analysis, including the possibility of negative risk premia, the transformation of alpha into beta, and the importance of macro factors and risk budgeting in asset-allocation policies.

Full PDF after the jump

Adaptive Markets and the New World Order

Category: Psychology, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

One Response to “Adaptive Markets and the New World Order”

  1. blackjaquekerouac says:

    how ’bout just inserting computer chips into people’s brains and front running the shit out the thing? that is all that’s going on, isn’t it? “spying”…for lack of a better word. this will not end well. at a certain level however…it could end GREAT as the total inability to make a living under any legal code whatsover yields the appropriate and inevitible ending.