Adapting the Efficient Market Hypothesis: a review of Andrew Lo’s Adaptive Markets

Theories of efficient markets mislead because they seek to explain market behaviour according to the laws of physics rather than biology, says Adaptive Market Hypothesis proponent Andrew Lo

The shark on the beach

Adaptive Markets: Financial Evolution at the Speed of Thought by MIT economist Andrew Lo recognises the EMH’s historic strengths, but seeks to integrate insights by Soros, Minsky and others into a new theory of how markets work. First published in 2017, and revised in 2019, it is not a new book: I was prompted to read it after reviewing Lo’s latest, In Pursuit of the Perfect Portfolio, a history of the development of passive investment theory written with Stephen R Foerster. But though well received, the book is still relatively little referenced in the mainstream financial and investor press.

Economics as physics

The perfectly rational homo economicus imagined by efficient markets proponents has, of course long been subject to critique, and indeed ridicule. Lo, is more generous, offering an intriguing account as to how economists came to propose such an unlikely model for human behaviour, and why some continue to defend it.

An adaptive index fund

In the latter part of the book he suggests how the AMH might be applied, offering ideas as to how investors might navigate markets that are rather more volatile by nature than theories of efficient markets allow. These is much rich material here that cannot be adequately summarised within the scope of a single review. But one is of immediate interest to day-to-day investors, a proposal for a ‘dynamic index fund’ designed to protect its holders from the severe market downturns that sit uneasily with the EMH, but which the AMH can more readily acknowledge.



A London-based business writer and essayist. See and @_justinwriter.

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