Shi Yuan Chen '08

I am interested in doing a research topic in finance.  The current topic I am exploring is Adaptive Markets Hypothesis.  The idea that focusing on how markets evolve over time appeals to me more so than assuming that humans are rational and that information would be distributed freely (Efficient Markets Hypothesis).  I learned in my institutional economics course that institutions tend to be path-dependent, meaning that their past states influence what kind of equilibrium they are able to reach.  Financial institutions are no different, and therefore one must look at the changes over time to find what investment strategies would be profitable.  Here are a few interesting conclusions from the Andrew Lo paper on AMH:

• It is possible to make excess profits in financial markets without taking on excess risk
• Risk/reward for any given strategy will change over time as other investors catch on
• Sticking to the same investment strategy will not produce the best returns (it may in the short run, but not in the long run)
• Innovation is the key to excess returns

Another interesting puzzle was the Grossman-Stiglitz Paradox, which states:

If a market were informationally efficient, i.e., all relevant information is reflected in market prices, then no single agent would have sufficient incentive to acquire the information on which prices are based.

So that basically covers what I am preparing to write about this year.  Some other potential topics I might go with include liquidity crisis or abnormal hedge fund returns.  I strongly encourage you to leave some kind of comment or feedback.  Thanks in advance.

A few books on the top of my reading list:

Investing: The Last Liberal Art by Robert Hagstrom

Advances in Behavioral Finance by Richard H. Thaler

Market Wizards by Jack D. Schwager