The Adaptive Markets Hypothesis

Abstract The Adaptive Markets Hypothesis (AMH) presents a new narrative that reconciles rational behaviour with periods of temporary financial insanity, and provides a formal and systematic exposition of the theory of the AMH and its many applications. In this narrative, intelligent but fallible investors learn from and adapt to changing environments. Financial markets may not always be efficient, but they are usually competitive and adaptive, varying in their degree of efficiency as investor populations and the financial environment change over time. This book describes how the AMH can make sense of market turmoil during crises, regardless of whether they have been induced by technological, financial, or public health factors, as well as the emergence and popularity of the efficient markets hypothesis (EMH) in the decades prior to these crises. The AMH is not an alternative to the EMH, but rather a broader framework that includes the EMH as a subset. Under stable, stationary, and predictable economic conditions, markets generally work well, and the EMH serves as a reasonably good approximation to reality. Under more dynamic and stochastic environments, the EMH becomes less plausible and behavioural anomalies emerge. The AMH provides an integrated and logically consistent framework for reconciling these disparate perspectives. For practitioners, the AMH offers practical insights with respect to investing in an economic climate of uncertainty and market turmoil. This book provides several applications including the analysis of hedge funds—the ‘Galápagos Islands’ of the financial industry—the ‘Quant Meltdown’ of August 2007, and the adaptation of financial institutions in the face of technological advances and changes in the financial industry’s competitive landscape.