Four Insightful Studies From Dr. Andrew Lo

Dr. Lo, a distinguished Professor at the Massachusetts Institute of Technology and Director of the MIT Laboratory for Financial Engineering, has contributed mightily to both quantitative and behavioral finance. He has been generous in sharing his articles online. Here are four that strike me as particularly relevant for readers.

Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and Empirical Implementation - In this study, Andrew Lo and colleagues show that it is, indeed, possible to create objective definitions of technical trading patterns and test their efficacy. Their study, conducted with data from the 1990s, found that some patterns do offer unique information to traders. David Aronson's more recent work casts doubt upon the validity of most technical patterns. This is a fascinating area of research and one that I hope to address, albeit in a more modest way, in the near future.

The Psychophysiology of Real-Time Financial Risk Processing - Dr. Lo and his team hooked traders up to biofeedback equipment to actually measure the degree to which emotional arousal impacts trading. It's a great look at how experienced traders differ from novices, and the study concludes with a thoughtful discussion of the role of emotion in trading.

Fear and Greed in Financial Markets: A Clinical Study of Day-Traders - Dr. Lo and colleagues (of which I was one) examined the role of personality in trading results. The results extend the findings of the earlier study regarding the role of emotion in trading, but raise questions as to the importance of personality traits in trading success.

Reconciling Efficient Markets With Behavioral Finance: The Adaptive Markets Hypothesis - Here Dr. Lo offers his alternative to the Efficient Markets Hypothesis by drawing upon evolutionary theory to show how markets adapt to a variety of conditions over time. This is an unusually insightful paper, and it makes a strong case that the market's risk premium varies according to the recent path of the stock market. Lo draws upon cognitive neuroscience to explain behavioral biases in financial decision-making. Ultimately, he argues, evolution determines market dynamics.