Adaptive Markets, Andrew M. Lo

https://www.amazon.com/Adaptive-Markets-Financial-Evolution-Thought/dp/0691135142

  • (2) The Adaptive Markets Hypothesis is based on the insight that investors and financial markets behave more like biology than physics
  • (3) Markets do look efficient under certain circumstances, namely when investors have had a chance to adapt to existing business conditions
  • (8) Financial markets are a product of human evolution and follow biological laws instead.
  • (33) The difference between economic nirvana and economic hell is due to one critical feature of the cobweb model: expectations
  • (34) future Nobel Prize winner Herbert Simon believed that firms only used part of the economic information available to them to make their forecasts and were limited in their reasoning ability. SImon called this theory: bounded rationality
  • (47) On the null hypothesis. We pretend that a particular hypothesis is true - what scientists call the null hypothesis - and then ask what the chanes are of seeing what actually happened given that pretend assumption. - Can be extended to analyzing a startup by asking what conditions need to be met for this outcome to eventuate
  • (52) As a Harvard fellow, Ellsberg gave a series of popular lectures at the Boston Public Library on political decision making in the uncertain conditions of the cold war
  • 'Risk, Ambiguity and the Savage Axioms', Daniel Ellsberg
  • 'Risk, Uncertainty and Profit' Frank Knight
  • (76) In fact we might call humankind the rationalizing animal
  • (93) When potentially significant events were taking place in the market the less experienced traders showed far more changes in blood volume amplitude, body temperature, and skin conductance. Less experienced traders were more sensitive to short-term changes in the market
  • (95) Traders who described more intense reactions to both losing and making money performed significantly worse than others. In addition, those who scored higher on a measure of "internality" - the tendency to ascribe the cause of various events in their lives to their own doing versus random chance - also performed much worse than those who scored lower on this scale
  • (104) From a neuroscientific perspective, emotions help to form an internal reward-and-punishment system that allows the brain to select an advantageous behavior
  • (148) This is a basic feature of selectoin, natural or artifical: the more diverse the pool of candidates, the more likely it is that any given selection criterion will be achieved
  • (165) Louis Pasteur once said, chance favors the prepared mind
  • (168) To someone who is convinced he knows the answer, there's no hope of any further enlightenment
  • (181) Shallow mathematical pyrotechnics
  • (188) Adaptive Markets Hypothesis: 
    • We are neither always rational or always irrational
    • Behavioral biases but can learn from the past and revise
    • Capacity for abstract, forward looking thinking, planning
    • Financial markets driven by our interactions as we behave, learn and adapt to the social, cultural, political, economic and natural environments in which we live
    • Survival is the ultimate force driving competition, innovation and adaption
  • (189) Behaviors are "irrational" but "maladaptive"
  • (195) Adaptive Markets Hypothesis predicts the only kinds of heuristics that survive will be those that hedge their bets to some degree
  • (217) Economic extensions of sociobiology: 
    • Evolutionary game theory
    • Evolutionary interpretation of economic change
    • Economies of complex adaptive systems
    • Broad applicability of biology to neoclassical economics
  • (219) Joseph Schumpeter took the Marxist idea of capital periodically destroying itself and spun it in a positive sense calling it "creative destruction" the necessary evolutionary innovation for the next phase of the capitalist system
  • (221) An efficient market is simply the steady sate limit of a market in  an unchanging financial environment
  • (277) Even these extraordinary accomplished hedge fund managers didn't have one perfect strategy that worked all the time. In other words, they needed to adapt
  • (279) The Lotka-Volterra equation: Explain why populations of species don't necessarily settle down and remain fixed, but rather can spontaneously oscillate over time (like the hog cycle)
  • (296) The financial system isn't a physical or mechanical system, but an ecosystem - a collection of interdependent species all struggling for survival and reproductive success in an ever-changing environment
  • (296) Identifying the most important sources of energy and nutrients in the system and studying how they flow through that system
  • (303) We've evolved to create narratives that suit our particular needs and desires
  • (312) The brain as a predictive machine. We can think of a narrative as an advanced for of simulation, using very high degree abstraction to describe phenomena
  • (321) Charles Perrow and Normal accidents. Perrow argued persuasively that the twin conditions of complexity and tight coupling were recipes for disaster in a variety of industry contexts
  • (321) Tight coupling: for the system to function properly, each component has to perform flawlessly - if only one component fails the entire system will come to a crashing halt
  • (322) Through the lens of the AMH we can see why the world of finance produces tight coupling, because in a highly competitive financial environment, firms naturally adapt to produce greater gains in efficiency and profit
  • (362) Groups aren't always the product of their biology, but sometimes created by the environment
  • (417) This is what the essence of leadership is, to create that vision and to inspire the rest of us with it.