Adaptive Market Hypothesis

AAA

DEFINITION of 'Adaptive Market Hypothesis'

A theory posited in 2004 by MIT professor Andrew Lo. It combines principles of the well-known and often controversial Efficient Market Hypothesis with principles of behavioral finance. Lo postulates that investor behaviors such as loss aversion, overconfidence and overreaction are consistent with evolutionary models of human behavior, which include actions such as competition, adaptation and natural selection.

INVESTOPEDIA EXPLAINS 'Adaptive Market Hypothesis'

Adaptive Market Hypothesis attempts to marry the rational, Efficient Market Hypothesis principles with the irrational behavioral finance principles. The theory states that humans make best guesses based on trial and error. For example, if an investor's strategy fails, he or she is likely to try a different strategy. If the strategy is successful, however, the investor is likely to try it again.


Adaptive Market Hypothesis applies the principles of evolution and behavior to financial interactions. Efficient Market Hypothesis states that it is not possible to "beat the market" because stocks always trade at their fair value, making it impossible to buy undervalued stocks or sell stocks for exaggerated prices. Behavioral finance attempts to explain stock market anomalies through psychology-based theories. Adaptive Market Hypothesis considers both as a means of explaining investor and market behavior.

RELATED TERMS
  1. Socionomics

    The study of the relationship between social mood and social ...
  2. Behavioral Finance

    A field of finance that proposes psychology-based theories to ...
  3. Market Psychology

    The overall sentiment or feeling that the market is experiencing ...
  4. Market Sentiment

    The overall attitude of investors toward a particular security ...
  5. Efficient Market Hypothesis - EMH

    An investment theory that states it is impossible to "beat the ...
  6. Dividend

    A distribution of a portion of a company's earnings, decided ...
RELATED FAQS
  1. What is an efficient market and how does it affect individual investors?

    When people talk about market efficiency they are referring to the degree to which the aggregate decisions of all the market's ... Read Full Answer >>
  2. What is the variance/covariance matrix or parametric method in Value at Risk (VaR)?

    The parametric method, also known as the variance-covariance method, is a risk management technique for calculating the value ... Read Full Answer >>
  3. How can you avoid the sunk cost trap?

    Avoid the sunk cost trap by recognizing that any investment you've made into a project or decision to date should not be ... Read Full Answer >>
  4. What is backtesting in Value at Risk (VaR)?

    The value at risk is a statistical risk management technique that monitors and quantifies the risk level associated with ... Read Full Answer >>
  5. What are the Basel III rules, and how does it impact my bank investments?

    The Basel III rules are a regulatory framework designed to strengthen financial institutions by placing guidelines pertaining ... Read Full Answer >>
  6. How do I discount Free Cash Flow to the Firm (FCFF)?

    Discounted free cash flow for the firm (FCFF) should be equal to all of the cash inflows and outflows, adjusted to present ... Read Full Answer >>
Related Articles
  1. Active Trading

    What Is Market Efficiency?

    The efficient market hypothesis (EMH) suggests that stock prices fully reflect all available information in the market. Is this possible?
  2. Fundamental Analysis

    7 Controversial Investing Theories

    We take a closer look at the theories that attempt to explain and influence the market.
  3. Active Trading

    Viewing The Market As Organized Chaos

    Find out how a cat and a ladybug prove markets are both random and efficient.
  4. Active Trading Fundamentals

    An Introduction To Behavioral Finance

    Curious about how emotions and biases affect the market? Find some useful insight here.
  5. Active Trading Fundamentals

    Efficient Market Hypothesis: Is The Stock Market Efficient?

    Deciding whether it's possible to attain above-average returns requires an understanding of EMH.
  6. Options & Futures

    Financial Concepts

    Diversification? Optimal portfolio theory? Read this tutorial and these and other financial concepts will be made clear.
  7. Economics

    Understanding the Fisher Effect

    The Fisher effect states that the real interest rate equals the nominal interest rate minus the expected inflation rate.
  8. Fundamental Analysis

    Explaining the Geometric Mean

    The average of a set of products, the calculation of which is commonly used to determine the performance results of an investment or portfolio.
  9. Chart Advisor

    Buying Opportunities on Upside Wedge Breakouts

    Find buying opportunities in these stocks, which have seen their prices break out of long-term declining wedge patterns.
  10. Stock Analysis

    Small-Caps and Dividends: Perfect Together

    For investors, small-caps shouldn’t be just about growth. They can be powerful income tools, as well.

You May Also Like

Hot Definitions
  1. Venture-Capital-Backed IPO

    The selling to the public of shares in a company that has previously been funded primarily by private investors. The alternative ...
  2. Merger Arbitrage

    A hedge fund strategy in which the stocks of two merging companies are simultaneously bought and sold to create a riskless ...
  3. Market Failure

    An economic term that encompasses a situation where, in any given market, the quantity of a product demanded by consumers ...
  4. Unsystematic Risk

    Company or industry specific risk that is inherent in each investment. The amount of unsystematic risk can be reduced through ...
  5. Security Market Line - SML

    A line that graphs the systematic, or market, risk versus return of the whole market at a certain time and shows all risky ...
  6. Tangible Net Worth

    A measure of the physical worth of a company, which does not include any value derived from intangible assets such as copyrights, ...
Trading Center