JOURNAL: Adaptive Markets

Andrew Lo, of MIT, has an interesting paper called, "The Adaptive Markets Hypothesis" (AMH) He applies evolutionary biology to trading strategies in financial markets. In short, the AMH theorizes that:

• The market environment's risk and reward ratios are constantly changing. Think of this as an evolving market ecology.
• Inefficiencies exist. There are arbitrage opportunities that can be exploited.
• Investment strategies wax and wan (due to their applicability to an evolving market ecology).
• Innovation is the key to survival. Rapid adaptation improves risk/reward.
• Survival is the only objective that matters. "While profit maximization, utility maximization, and general equilibrium are certainly relevant aspects of market ecology, the organizing principle in determining the evolution of markets and financial technology is simply survival."

All of Lo's rules for traders and investors participating in financial markets apply to global guerrillas engaged in open source warfare. It also implies that static doctrines (as we see in conventional militaries) and formulas for nation-building are likely to break given rapid changes in the warfighting ecology.

In contrast, the trial and error approach of local actors, often yields improvements in methods that improve risk/reward ratios. These local innovators can quickly find and exploit arbitrage opportunities (risk free success) when they arise. Local strategies can also be quickly replicated across the horizontal networks of open source warfare (which may allow locally developed innovation to apply to the strategic level through the emergent intelligence of the aggregate network). Finally, the only goal we may be able to discern from an open source warfare movement is the need to survive (beyond being a "old saw" of guerrilla warfare, it also explains the movement's rapid adoption of transnational crime and its rapidly changing target sets).

Comments

[Duncan Kinder]

This sounds a lot like the distinction between "hill people" and "plains people" posited by the Annales historian Fernand Braudel.

According to Braudel, hill people differed fundamentally from plains people for three reinforcing reasons:

1) They were groups that had been driven to the hills - e.g., the Welsh. Hence, they are alienated from plains society.

2) Anti-social individuals within plains society from time to time had to "head to the hills."

3) The geography of hill country placed a premium on individual initiative and ad hoc solutions over normative institutions and traditional values, which the plains favored.

As a result, distinctly different hill peoples have emerged. This is geographically, not culturally determined. Hence, whether we are talking about the Highlanders in Scotland, the Basques in Spain, or the Berbers in Morocco, all are hill peoples that share common individualistic, ad hoc, values as opposed to the normative values of the surrounding plains people.

I distinctly recall articles that discuss the Afghans as hill peoples.

A great deal of "terrorism" might be characterized as the exuberance of hill peoples and the discomfort of plains people in the face of relative chaos. Robb’s contribution appears to be how this conflict interacts with modern networks and other technology.

[Will]

Following some sublinks in an earlier post, I discovered the work of Cosma Shalizi (his PhD dissertation was referenced). An article he wrote for the Santa Fe Institute describing the work of Scott Page on "the logic of diversity" outlines how "inept" agents working on a problem can out-perform the "experts."

Page's insights provide further evidence for the efficacity of guerrilla warfare and provide a framework for one aspect of how and why they outperform the military experts.

See: http://cscs.umich.edu/~crshalizi/bulletin/logic-of-diversity.html

[daCascadian]

Duncan Kinder >"This sounds a lot like the distinction between "hill people" and "plains people" posited by the Annales historian Fernand Braudel..."

As well as R. Buckminster Fuller`s distinction between "dry landers" & "ocean goers"

Reaction to their specific environment drives evolution of behavior by groups

"Self-mastery is the key to the portals of the universe" - Joseph W. Kittinger

[John Robb]

Thanks Duncan. What happens when multiple plains people and the hill people are thrown together into a chaotic common market and communications milieu too complex and big for the any one plains people to dominate?

[Arno]

The tribes of the Middle and Northern Zagros and Caucasus mountains (Iran, Turkey, Kurdistan, Armenia) are excellent examples of "hills people". A large part of recent (20th century) history of the region can be explained by their interaction with the plains people (persians, arabs, turks), not to mention the English and Russian invaders. The Marsh Arabs of Southern Iraq could also count as "hills people". Looks like an interesting role reversal, doesn't it?

[Duncan Kinder]

"Thanks Duncan. What happens when multiple plains people and the hill people are thrown together into a chaotic common market and communications milieu too complex and big for the any one plains people to dominate?"

Have you ever heard of Ghengiz Khan?

I really don't know, but the Arab historian Ibn Khaldun posited a theory whereby vigorous hill people tyes would ultimately overcome increasingly weak and decadent plains people types.

I have speculated that Khaldun has influenced Braudel, but I really am not sure of this.

Khaldun would be another resource to consider, however.

[Duncan Kinder]

The following New York Times article discusses how the 10th Mountain Division is adjusting its tactics to respond to the Afghans' hill peoples ethos.

http://www.nytimes.com/2006/02/16/nyregion/16fort.html