Should-Read: Diane Coyle: Economics in Transition: Adaptive Markets

Should-Read: Diane Coyle: Economics in Transition: Adaptive Markets: “Adaptive Markets, by MIT’s Andrew Lo, gives a superb and fascinating account of thinking on the frontier… https://www.project-syndicate.org/onpoint/economics-in-transition-by-diane-coyle-2017-06

…the kind of approach rooted in biology and psychology that Richard Bookstaber… advocates in the final part of The End of Theory….One of the most effective points made by advocates of Fama’s now-notorious Efficient Markets Hypothesis is that it is in fact difficult to beat the market; profit-making opportunities are swiftly arbitraged away. And, indeed, Lo argues that when financial markets are stable enough for long enough, the rationality-based model is appropriate. But the moment there is any instability, human fear, greed, culture, behavioral norms, storytelling, and imagination kick in. The environment determines the way market participants behave….

The test of the adaptive markets approach, though, must be how it helps to predict, avert, or respond to financial crises…. Financial markets need to be viewed–by investors and regulators alike–as an ecosystem. The lesson from biology is that systems require feedback loops in order to regulate themselves…. Lo urges regulators to think of these feedback loops–literally–systematically, and proposes using network theory to map the whole of the financial regulatory system. Not surprisingly, the outcome of this exercise for the United States is not reassuring…