Andrew Lo’s theory of how economic actors mimic ecological ones
Adaptive Markets: Financial Evolution at the Speed of Thought. By Andrew Lo. Princeton; 483 pages; $37.50 and £31.95.
ECONOMISTS have been accused of “physics envy”, an obsession with constructing precise mathematical models instead of studying the real, messy, world. But a new book suggests that economists have been looking at the wrong science; they should have focused on biology.
The idea stems from the school of “behavioural economics” which observes that humans are not the kind of hyper-rational calculating machines that some models rely on them to be. As a result, markets are not always “efficient”—accurately pricing all the available information.
When Andrew Lo was a young academic, he presented a paper at a conference which showed that one of the key assumptions of the efficient market hypothesis was not borne out by the data. He was instantly told that he must have made a programming error; his results could not possibly be right.
Mr Lo, who is now a professor at MIT, has spent much of his career battling to steer economics away from such narrow-minded thinking. His grand idea is the “adaptive markets hypothesis”. The actions of individuals are driven by intellectual short cuts—rules of thumb that they use to make decisions. If those decisions turn out badly, they adapt their behaviour and come up with a new rule to follow.