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Frontiers of Finance: Evolution and Efficient Markets

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  • J. Doyne Farmer
  • Andrew W. Lo

Abstract

In this review article, we explore several recent advances in the quantitative modeling of financial markets. We begin with the Efficient Markets Hypothesis and describe how this controversial idea has stimulated a number of new directions of research, some focusing on more elaborate mathematical models that are capable of rationalizing the empirical facts, others taking a completely different tack in rejecting rationality altogether. One of the most promising directions is to view financial markets from a biological perspective and, specifically, within an evolutionary framework in which markets, instruments, institutions, and investors interact and evolve dynamically according to the "law" of economic selection. Under this view, financial agents compete and adapt, but they do not necessarily do so in an optimal fashion. Evolutionary and ecological models of financial markets is truly a new frontier whose exploration has just begun. Published in Proceedings of the National Academy of Science 96(1999) 9991-9992.

Suggested Citation

  • J. Doyne Farmer & Andrew W. Lo, 1999. "Frontiers of Finance: Evolution and Efficient Markets," Working Papers 99-06-039, Santa Fe Institute.
  • Handle: RePEc:wop:safiwp:99-06-039
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    References listed on IDEAS

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    1. Arthur, W.B. & Holland, J.H. & LeBaron, B. & Palmer, R. & Tayler, P., 1996. "Asset Pricing Under Endogenous Expectations in an Artificial Stock Market," Working papers 9625, Wisconsin Madison - Social Systems.
    2. J. Doyne Farmer, 2002. "Market force, ecology and evolution," Industrial and Corporate Change, Oxford University Press, vol. 11(5), pages 895-953, November.
    3. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
    4. Friedman, Daniel, 1991. "Evolutionary Games in Economics," Econometrica, Econometric Society, vol. 59(3), pages 637-666, May.
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    Keywords

    Finance; efficient markets; market evolution;
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