This is a book written by Andrew W. Lo, a Professor of Finance at MIT Sloan School of Management. This book is about a new theory in financial economics proposed by the author, namely the Adaptive Market Hypothesis. He thinks that this theory explains the financial market better than the Efficient Market Hypothesis.
Layout of Adaptive Markets
The introduction briefly talks about the need of a new theory and introduces the Adaptive Market Hypothesis.
The first five chapters touch on some basic economic theories and use the results from biology, neuroscience, psychology, sociobiology and theory of evolution to point out the need of a new theory.
Chapter six to eight discuss the Adaptive Market Hypothesis.
In chapter nine and ten, he talks about the financial crisis and the weaknesses in the current financial system. The author also offers suggestions to fixing these problems in chapter eleven.
The last chapter is his conclusion, offering his vision and prescription for the future.
Highlights
How does a new theory help in our investment journey? Honestly, I think it serves as a building block in devising our investment strategy. Below are the lessons that I learned from this book.
First, unlike the Efficient Market Hypothesis, the Adaptive Market Hypothesis acknowledges that there is inefficiency to be exploited in the market, thus explaining the spectacular performance of some well-known investors. It also dispels the assumption that humans always make rational decision. Thus, the chance of making big profit in the stock market is possible according to this theory.
Furthermore, the author explains the market behaviour and investor actions through the lens of a few different disciplines. These references make us more aware of how biology and evolution affect our investment decisions. The author also gives some very interesting suggestions as to how the future of financial market should be. Our investment returns will be based on our adaptation to the changing environment.
Conclusion
Adaptive Markets does not offer concrete steps to investing as this book is more like a textbook. Nonetheless, I find its narrative to be quite interesting as compared to normal textbooks. I have gained a few new perspectives regarding the financial market from this book. By understanding human nature and its interaction with the market, I hope that I can reduce my investment mistakes.
As usual, before I end, I will share some quotes from the book.
“The Adaptive Markets Hypothesis is based on the insight that investors and financial market behave more like biology than physics, comprising a population of living organisms competing to survive, not a collection of inanimate objects subject to immutable laws of motion.”
“Economic expansions and contractions are the consequences of individuals and institutions adapting to changing financial environments, and the bubbles and crashes are the result when the change occurs too quickly.”
“The wisdom of crowds depends on the errors of individual investors cancelling each other out.”
“We behave, think, reach conclusions, and make decisions with the effects of the emotional brain always running in the background.”
“Fear is a very efficient mechanism for learning.”
“Most of our savings behaviour is the result of environment, culture, education, public policy, and logical deliberation.”
“Managing emotion is critical for making good financial decisions.”
“Emotion is the primary feedback mechanism that causes us to update our heuristics.”
“Watching the hedge fund can give us tremendous insight into what’s happening to the market environment.”
“Human behaviour is the ultimate reason accidents happen and become the norm.”
“We shouldn’t let finance drive our goals; our goals should be driving finance.”
Recommended book
If you are interested in Adaptive Markets, you may get the book from Kinokuniya Malaysia through the link below*.
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