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Financial Market Dynamics and Human Behavior

Andrew LoAndrew Lo

Faculty: Andrew Lo

“Whether students are pursuing career opportunities in financial services or any other industry, this course will help them better understand the interconnectedness and dynamics of the entire business ecosystem.” – Andrew Lo

From the Bulletin: This course develops a new perspective on the dynamics of financial markets and the roles that human behavior and the business environment play in determining the evolution of behavior and institutions. Although neoclassical economic theories such as expected utility maximization, rational expectations, general equilibrium, and efficient markets have dominated the literature on economic behavior and market structure, recent advances in the cognitive neurosciences, artificial intelligence, computational social science, and evolutionary biology provide a number of new insights into market dynamics. We will draw on these diverse disciplines to develop a more complete understanding of human behavior in the specific context of markets and other economic institutions. Recent academic research will be the main focus of the course, but topics will be motivated and illustrated by practical applications from financial markets, the hedge fund industry, private equity, government regulation, and political economy. Using the ideas from this new perspective, we will formulate several new hypotheses regarding recent challenges to traditional economic thinking, including: how financial crises are formed and whether or not they can ever be eliminated; why certain investment strategies seem to wax and wane; where business cycles come from; what role ethics plays in financial intermediation; whether capitalism is more sustainable than other political systems; and why financial engineering may be the solution to some of society’s biggest challenges.

CURRICULUM

A number of exceptions to standard financial theories have emerged over the last couple of decades, the financial crisis being the most prominent, but not the only, example. To understand the nature and origin of these exceptions, Professor Andrew Lo recognized the need to extend and, in some cases, overturn the theories that the School traditionally taught with more sophisticated alternatives. This new framework allows students to examine departures from rationality and efficiency in a systematic way, resolving theoretical contradictions as well as providing a number of concrete implications for business practice.

THE STUDENT EXPERIENCE

Economists, psychologists, and neuroscientists have pioneered a series of recent breakthroughs in our understanding of human behavior that have significant implications for business and management. Professor Lo is focused on making those breakthroughs more accessible, giving students the necessary tools to apply these ideas in their own careers. What does that look like? The course develops a consistent intellectual framework in which students can think about generating value for themselves and their firms. In true MIT fashion, students are given the skills to understand complex intellectual paradigms and then leverage that knowledge in very practical ways when they enter the workforce. In particular, this course offers a reconciliation of efficient markets with investor psychology in a way that not only is intellectually satisfying, but also is ultimately quantifiable and actionable—a unique aspect of the course.

RESEARCH DRIVERS

The MIT Sloan Finance Group has had a long and illustrious tradition of bringing research into the classroom—in many cases before research is published. The best of this tradition dates back to 1970 when the Black-Scholes-Merton options pricing was first taught to Sloan Master’s students three years before these ideas were published in academic journals in 1973. In this class, Lo is able to bring his research front and center in every lecture. “It’s a real privilege and treat for me to be able to offer a course like this because I can teach what I do in my research, not just in one or two lectures, but throughout the entire semester,” Lo observes. “It’s also one of the biggest thrills for an academic—to have a classroom full of the brightest students in the world, all looking to put these ideas to work when they graduate.”

Andrew Lo is the Charles E. and Susan T. Harris Professor, Professor of Finance, and Director of the Laboratory for Financial Engineering.