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Excerpt
What drives our responses to risk and uncertainty, and how can we improve them? In his 2017 book, Adaptive Markets: Financial Evolution at the Speed of Thought, MIT Sloan finance professor Andrew Lo answers that question using evolutionary concepts and insights, including competition, innovation, reproduction, and adaptation.
While his main interest is in applications to financial market settings and explaining why the physics-like principles used to explain “efficient markets” may be inadequate, the book offers fascinating insights for readers interested in various kinds of risk and our responses to them. To develop his “Adaptive Markets Hypothesis,” Lo takes readers on an interesting and enjoyable excursion through the natural sciences, including ecology, biology, neurology, and psychology, to examine the nature of adaptation and human intelligence, and to explain observed behavior and attitudes toward risk and uncertainty.
Lo's basic thesis is that we cannot explain how humans anticipate and respond to risk without understanding the selective pressures of past evolutionary environments. He observes that “economic behavior is but one aspect of human behavior, and human behavior is the product of biological evolution across eons of different environments” (p. 8). For example, strong emotional reactions can suppress rational thought, leading us to overreact to perceived risks. While this may have ensured our ancestors’ personal survival (causing them to flee from a charging grizzly bear, for example), fear-driven reactions can be counterproductive when facing many of today's challenges and often lead to suboptimal decisions.