Survival of the Richest

In financial markets, as in many human endeavors, there’s a battle between reason and madness. On one side are the disciples of the efficient-markets hypothesis: the notion that markets fully, accurately, and instantaneously incorporate all relevant information into prices. These adherents assume that market participants are rational, always acting in their own interest and making […]

by

Andrew W. Lo

by

Andrew W. Lo

From the Magazine (March 2006)

Summary.

Reprint: F0603A

Are financial markets driven by efficiency or by irrational behavior? The “adaptive markets hypothesis” brings Darwinian principles into the mix, suggesting that neither is the case.

In financial markets, as in many human endeavors, there’s a battle between reason and madness. On one side are the disciples of the efficient-markets hypothesis: the notion that markets fully, accurately, and instantaneously incorporate all relevant information into prices. These adherents assume that market participants are rational, always acting in their own interest and making mathematically optimal decisions. On the other side are the champions of behavioral economics: a younger discipline that points to bubbles, crashes, panics, manias, and other distinctly unreasonable phenomena as evidence of irrationality.

A version of this article appeared in the March 2006 issue of Harvard Business Review.

AL

Andrew W. Lo (alo@mit.edu) is the Harris & Harris Group Professor at MIT’s Sloan School of Management and the director of the MIT Laboratory for Financial Engineering, both in Cambridge, Massachusetts.

Survival of the Richest

Partner Center

Explore HBR

HBR Store

About HBR

Manage My Account

Follow HBR