A longstanding academic theory for describing how markets work has finally died. Its impact on investment theory and practice was enormous, but has also led to some risks.
The so-called efficient market hypothesis (EMH), which basically assumes that investors are rational and that it’s impossible to beat the market because prices reflect all available information, has been under fire for years.
And MIT’s Andrew Lo, who Time Magazine named as one of the 100 most influential people in the world in 2012, finally put an end to it in his new book, ‘Adaptive Markets: Financial Evolution at the Speed of Thought.’
We recently spoke with him on FS Insider about his book and the theory that will replace the old one. It’s called the adaptive market hypothesis (AMH), which looks at the market less as a high-performance supercomputer and more as a biological organism or ecosystem – an ecosystem that, unfortunately, has become less diverse and more fragile in recent years.
The Adaptive Markets Hypothesis
The basic premise is that market participants are human, Lo noted. This has implications, including that while these people can come together and form a great decision-making apparatus – the market itself – they still make mistakes. They then learn from these mistakes and adapt to changing market conditions.
This post was published at FinancialSense on 07/11/2017.