Economic behavior from an evolutionary perspective

Abstract

The conflict between rational models of economic behavior and their systematic deviations, often referred to as behavioral economics, is one of the most hotly debated issues in social sciences. This thesis reconciles the two opposing perspectives by applying evolutionary principles to economic behavior and deriving implications that cut across species, physiology, and genetic origins. In the context of a binary-choice model, we first show that risk aversion emerges via natural selection if reproductive risk is "systematic", i.e., correlated across individuals in a given generation. The degree of risk aversion is determined by the stochastic nature of reproductive rates, and different statistical properties lead to different utility functions. More generally, irrational behaviors are not just mere divergence from rationality, but seeds necessary for successfully coping with environmental transformations. Furthermore, there is an optimal degree of irrationality in the population depending on the degree of environmental stochasticity. When applied to evolutionary biology, we show that what appears to be group selection may, in fact, simply be the consequence of natural selection occurring in stochastic environments with "systematic" risks. Those individuals with highly correlated risks will appear to form "groups", even if their actions are totally autonomous, mindless, and, prior to selection, uniformly randomly distributed in the population. Evolutionary principles can also be used to model the dynamics of financial markets. In a multiperiod model of the contagion of investment ideas, we show that heterogeneous investment styles can coexist in the long run, implying a wider variation of diverse strategies compared to traditional theories. These results may provide new insights to the survival of a wide range of hedge funds. In a model that investors maximize their relative wealth, the initial wealth plays a critical role in determining how the optimal behavior deviates from the Kelly Criterion, regardless of whether the investor is myopic or maximizing the infinite-horizon wealth.