The Adaptive Markets Hypothesis: Market Efficiency from an Evolutionary Perspective

The 30th anniversary of The Journal of Portfolio Man-agement is a milestone in the rich intellectual his-tory of modern finance, firmly establishing therelevance of quantitative models and scientific inquiry in the practice of financial management. One of the most enduring ideas from this intellectual history is the Effi-cient Markets Hypothesis (EMH), a deceptively simple notion that has become a lightning rod for its disciples and the proponents of behavioral economics and finance. In its purest form, the EMH obviates active portfo-lio management, calling into question the very motivation for portfolio research. It is only fitting that we revisit this groundbreaking idea after three very successful decades of this Journal. In this article, I review the current state of the con-troversy surrounding the EMH and propose a new per-spective that reconciles the two opposing schools of thought. The proposed reconciliation, which I call the Adaptive Mar-kets Hypothesis (AMH), is based on an evolutionary approach to economic interactions, as well as some recent research in the cognitive neurosciences that has been transforming and revitalizing the intersection of psychology and economics. Although some of these ideas have not yet been fully articulated within a rigorous quantitative framework, long time students of the EMH and seasoned practitioners will no doubt recognize immediately the possibilities generated by this new perspective. Only time will tell whether its potential will be fulfilled. I begin with a brief review of the classic version of the EMH, and then summarize the most significant criti-cisms leveled against it by psychologists and behavioral economists. I argue that the sources of this controversy can