P03PfYgNjmw.pdf - MITOCW | watch?v=P03PfYgNjmw The following content is provided under a Creative Commons license Your support will help MIT

P03PfYgNjmw.pdf - MITOCW | watch?v=P03PfYgNjmw The...

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MITOCW | watch?v=P03PfYgNjmwThe following content is provided under a Creative Commons license. Your support will help MITOpenCourseWare continue to offer high-quality educational resources for free. To make a donation or to viewadditional materials from hundreds of MIT courses, visit MIT OpenCourseWare at ocw.mit.edu.ANDREW LO:Any questions from last lecture? Where we left off last time was the adaptive marketshypothesis. The fact that markets are not always in everywhere efficient, but rather they satisfythe following six properties that I listed at the end of last lecture.Individuals act in their own self-interest, but they make mistakes. However, they learn andadapt, and competition drives that adaptation and innovation. Natural selection, essentially, isthe mechanism that shapes the survival of the heuristics And in the end, the only thing thatmatters is survival. Now I illustrated how heuristics develop by giving you an example of theproblem of getting dressed in the morning. And I pointed out that each of us have our ownheuristics that have been developed over many, many years of selection of various differentsorts.So when you take this all together and you put them into a framework that tries to focus onunderstanding market dynamics, you get a number of implications that are actually quitedifferent from that of efficient markets. Let me tell you what they are. I'll give you someexamples.One of the implications is that the risk-reward trade-off the relationship between risk andexpected rate of return, like the CAPM's security market line. That's not stable over time orover circumstances, because individual preferences are not stable over time or overcircumstances. I'll give you an example of that. Anybody know somebody who has livedthrough the Great Depression, OK, so grandparents or great-grandparents? My guess is thatif you talk to them, or if you even observe their habits, they're actually quite different from yourparents and yourselves in terms of how frugal they, are how careful they are with money, withresources, even something as simple as turning off the lights.A friend of mine is a customer a very wealthy family. They own a private business. And so theirfamily's net worth today is probably in the order of $300 million, which, even in today'seconomy is worth a lot. Actually, it's worth more than what it used to be worth now.And so this family, the patriarch, the matriarch is their grandmother, who lived through theGreat Depression. And she lives in Lower Manhattan in a relatively small, nondescriptapartment, despite the fact that the family, you know, my friend's parents, live in a beautiful
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penthouse apartment on Park Avenue. And they keep asking the grandmother to move in withthem.
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  • Spring '17
  • Jim Angel

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