Adaptive Markets and Quarterback Contracts

One of my favorite professors at MIT Sloan was Andrew Lo, a legend in the field of finance. Perhaps his greatest contribution to the industry was the Adaptive Markets Hypothesis, which argues that markets are not purely efficient but rather governed in part by the laws of evolutionary biology. The prevailing theory in financial markets even today is the Efficient Markets Hypothesis, which tells us that participants are all rational and acting on the same information, thus resulting in a natural equilibrium when it comes to stock prices for example. This means in the long-run, it is not possible to “beat the market.” Professor Lo, however, argues that market participants model their behavior on their past experiences, constantly learning and adapting based on their successes and mistakes. Evolutionary biology, he argues, can easily explain “irrational” behavior such as fear, overconfidence, loss aversion, and more. Investors, he argues, are more likely to double down on strategies that

One of my favorite professors at MIT Sloan was Andrew Lo, a legend in the field of finance. Perhaps his greatest contribution to the industry was the Adaptive Markets Hypothesis, which argues that markets are not purely efficient but rather governed in part by the laws of evolutionary biology. The prevailing theory in financial markets even today is the Efficient Markets Hypothesis, which tells us that participants are all rational and acting on the same information, thus resulting in a natural equilibrium when it comes to stock prices for example. This means in the long-run, it is not possibl