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What is the adaptive market hypothesis?

What is the adaptive market hypothesis?

The Adaptive Market Hypothesis uses theories of behavioral economics to update the aging Efficient Market Hypothesis.

There have been many debates surrounding the Efficient Market Hypothesis and its validity, and a lot of research over the last 15 years or so has been done which suggests that behavioral finance holds many of the keys to an accurate “universal theory” of the markets.

A marriage between the two schools of thought has given birth to the Adaptive Market Hypothesis, coined in 2004 by Andrew Lo of MIT. Behavioral and evolutionary principals come into play when theorizing about the large-scale behavior and adaptation of humans in a system.

Together with the tenets of the efficient market hypothesis, the theory gives us a more realistic lens through which to interpret the markets and the explain the anomalies and inefficiencies that are not addressed by the Efficient Market Hypothesis alone.

Behavioral ideas such as trial and error, self-serving bias, and hive mentality bring the human element to a discussion which previously lacked it.

Keywords: behavioral economics, efficient market hypothesis, evolution, market psychology, emotional investing, universal theory,