Investing: The Last Liberal Art (Columbia Business School Publishing)

by Robert G. Hagstrom

reallocated—or, in biological terms, there is a change in population. As Farmer notes, “The long-term evolution of the market can be studied in terms of flows of money. Financial evolution is influenced by money in much the same way that biological evolution is influenced by food.”15 Why are financial strategies so diverse? The answer, Farmer believes, starts with the idea that basic strategies induce patterns of behavior. Agents rush in to exploit these obvious patterns, causing an ultimate side effect. As more agents begin using the same strategy, its profitability drops. The inefficiency becomes apparent, and the original strategy is washed out. But then new agents enter the picture with new ideas. They form new strategies of which any number may become profitable. Capital shifts and the new strategy explodes, which starts the evolutionary process again. It is the classic El Farol Problem described by Brian Arthur.