Adaptive Markets

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 Galapagos 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.

Winner of PROSE Award for Business, Finance & Management, Association of American Publishers 2018
Winner of PROSE Award for Excellence in Social Sciences, Association of American Publishers 2018
Commended for 2017 TIAA Paul A. Samuelson Award, TIAA Institute 2017
Commended for 2017 TIAA Paul A. Samuelson Award, TIAA Institute 2017
Short-listed for Bloomberg's Best Books of 2017, chosen by Robert Shiller 2017
Short-listed for Bloomberg's Best Books of 2017, chosen by Vitor Constancio 2017
Short-listed for "Financial Times" (FT.com) Best Books of 2017: Economics 2017
Short-listed for Microsoft Best Business Books of 2017 2017
Short-listed for "The Wall Street Journal"'s What Business Leaders Read in 2017 2017
Short-listed for "MoneyWeek"'s "Five of the best books of 2017" (chosen by Dr. Matthew Partridge) 2017

“Winner of the 2018 PROSE Award for Excellence in Social Sciences, Association of American Publishers”

"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 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.

"Andrew Lo combines wonderfully broad scholarship and a delightfully instructive style to present dramatically new perspectives on how markets work and how they can be regulated more effectively. This important book will teach and entertain, and should influence those charged with keeping markets healthy." --Simon A. Levin, Princeton University " Adaptive Markets will appeal to anyone who distrusts dogmatic economic theories and thirsts for a coherent view of how market economies produce both great gain and great pain for societies. Andrew Lo integrates a deep understanding of finance with a broad knowledge of biology, psychology, and ethics to offer a tantalizing vision of how financial engineering could become a powerful force for a more just, healthy, and prosperous world." --Peter Hancock, President and CEO, AIG "We tell stories, we learn from them, and we make them up. In this magnificent book, Andrew Lo explains how our attraction to stories drives markets, explains past catastrophes, and suggests future opportunities for world-saving financial engineering. And he packages it all in fascinating stories of his own." --Patrick Henry Winston, Massachusetts Institute of Technology "Andrew Lo is a brilliant financial economist, visionary innovator, bold contrarian, gifted writer, and an unrelenting idealist. These traits are evident in this wonderful book, which traces the 'evolutionary explosion of financial innovation' that began with Vanguard's creation of the first index mutual fund in 1974, tracking the S&P 500 Index. I continue to hold to index funds, but Dr. Lo's book persuades me to keep a mind that is open--or at least ajar--to the new world of investment technology, investor preferences, and transaction efficiency, and to the wisdom of those who are smarter than I am." --John C. Bogle, founder of the Vanguard Group and the First Index Mutual Fund, and author of The Little Book of Common Sense Investing "This is a wonderful book. Andrew Lo traces a journey in which he reconsiders rationality in economics, moving from the efficient market hypothesis to his own Adaptive Markets Hypothesis through psychology, neuroscience, biology, and studies of financial innovations and crises. The book presents many valuable findings and is also full of emotion--enthusiasm, joy, frustration, and pain. It is itself a manifestation of the important finding that rational thinking and emotion go together." Nobuhiro Kiyotaki, Princeton University

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 Galapagos 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.

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