Examining financial puzzles from an evolutionary perspective

Abstract

In this thesis, we examine some puzzles in finance from an evolutionary perspective. We first provide a literature review of evolutionary psychology, and discuss three main findings; the frequentist hypothesis, applications from risk-sensitive optimal foraging theory, and the cheater detection hypothesis. Next we introduce some of the most-researched puzzles in the finance literature. Examples include overreaction, loss aversion, and the equity premium puzzle. Following this, we discuss risk-sensitive optimal foraging theory further and examine some of the financial puzzles using the framework of risk-sensitive foraging. Finally, we develop a dynamic patch selection model which gives the patch selection strategy that maximizes an organism's long-run probability of survival. It is from this optimal patch strategy that we observe loss aversion. Throughout the thesis, we stress the following: humans' behavior in financial markets is neither inherently irrational, nor is it rational. Rather the puzzles occur as a consequence of evolutionarily-optimal cognitive mechanisms being utilized in environments other than the ancestral domain in which they evolved to adapt in.