Efficiency May Be Special Case of Adaptation

Apr 24th, 2012 | Filed under: Alpha Strategies, Behavioral finance, Hedge Fund Strategies, Today's Post | By:
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Andrew Lo says, in a new paper refining a hypothesis he first presented eight years ago, that the hedge fund industry is the “Galapagos islands” of the financial globe. It is the place where the underlying evolutionary dynamic becomes most obvious.

Lo has been pressing and expanding his “Adaptive Markets Hypothesis” at least since 2004, when he wrote a paper with that phrase in its title for the Journal of Portfolio Management. The gist of it was that although the ECMH postulates individuals who “maximize expected utility and have rational expectations,” an adaptive hypothesis postulates “organisms that have been honed, through generations of natural selection, to maximize the survival of their genetic material.”

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Author Bio:
Christopher Faille is a Jamesian pragmatist. William James has taught him, for example, that "you can say of a line that it runs east, or you can say that it runs west, and the line per se accepts both descriptions without rebelling at the inconsistency."

4 comments
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  1. [...] – Refining Adaptive Markets Hypothesis. [...]

  2. [H]e produces a striking graph that shows the “Great Modulation,” the period from about 1938 until 2008. Now that we have five year’s distance from its end [...]”

    Shouldn’t it be “from about 1938 to 1998″, instead of 2008? Then that would make “Now that we have fourteen years distance from its end”, instead of five years.

  3. Martin,

    It is Lo’s view that the great modulation continued throughout the 1990s. As you’ll see from the graph above, even during the various crises (LTCM etc.) of the 1990s AND through the dotcom boom of the start of the new millennium, 30 percent remained an effective ceiling on vol. It was only a quant meltdown in the summer of 2007 that caused an exodus of cash from equity neutral strategies, and that in turned allowed for the extreme volatility event (above 50 percent) in 2008.

  4. [...] The adaptive markets hypothesis [Academic] – AllAboutAlpha [...]

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