Bringing Evolutionary Thinking Into Economics and Finance

There are a few moments in life that feel like an electric zap to the brain or heart -- after that moment, nothing is the same.  Learning about evolution by means of natural selection was such for me, as it suddenly made sense out of a very basic question — how did people come to be?  It did so with one of the most elegant and compelling arguments I had ever heard. A reinforcing zap came from reading Richard Dawkins’ The Selfish Gene,¹ and its explanations about how fitness maximization can promote cooperation, not just competition and conflict; and his prescient discussion of how Darwinian selection applies to cultural traits (or memes), not just to genes.  (Dawkins did not fully appreciate the possible role of multilevel selection in promoting cooperation, but it is an astonishing book all the same.)²

I knew from a young age that I wanted to be an economist, and had a strong inkling that I wanted evolutionary ideas to be part of my contribution as a scholar. So over the years, I read popular accounts of evolutionary ideas, and (as an amateur) scholarly work on evolutionary theory.

For aspiring scholars, there is a wealth of options for learning about evolutionary thinking as a foundation for applications in economics.  Biologists could do better than me for recommending a general text on the mathematics of evolutionary theory (though I did dig into this). A very readable book on evolutionary dynamics is.³ I liked very much the seven-part series of expository essays on the mathematics of natural selection in the Journal of Evolutionary Biology by my UC Irvine colleague Steven Frank, starting with.⁴ For an introduction to cultural evolutionary theory and empirics.⁵

My attraction to evolutionary thinking was greatly influenced by many conversations with my dad, who wrote early think pieces back in the 1970s on evolution and economics with titles such as “Economics from a Biological Viewpoint,”⁶ and “Natural versus Political Economy.”⁷ What better way for a young person to learn about both Adam Smith and Darwin! One of my dad’s research contributions in this area⁸ was entitled "On the Emotions as Guarantors of Threats and Promises." (Extra points if you detected the faint mash-up echo of two Darwin titles: On the origin of species… and The expression of the emotions in man and animals.) His paper analyzed how feelings of love, friendship, or hatred could act as commitment devices -- commitments to help potential allies and punish potential enemies.  So these emotions, by overcoming reason, could actually make the individual better off. (These ideas were extended insightfully by economist Robert Frank.) This helps explain why such emotions evolved.

I always found it strange that my dad did research from an evolutionary perspective, and provided an explanation for why people are imperfectly rational, yet for economic research, in general, was in large part a proponent of the traditional fully-rational paradigm. In my own modeling work, I usually recognize both the rational aspects of human decision-making (people think about their options and try to choose the best one) and systematic bias as well.

I find it even stranger that many in the field of behavioral economics and finance seem to have little or no interest in an evolutionary understanding of the human mind. (How can we hope to understand psychology except in the light of evolution? This would be like doing chemistry but having no interest in physics.) Ironically, some of the criticisms I hear about evolutionary psychology have some of the same flavor as early criticisms of behavioral economics: “My default assumption will be that this new approach is wrong and useless unless absolutely proven otherwise. I’ll set a mile-high bar for concepts derived from this approach but not for the ideas that I’m more accustomed to.”

I’m not saying that resistance to evolutionary thinking is huge---the bigger problem is indifference. The advice I’d give to aspiring scholars is that there is often an extremely high payoff to ideas that are both right and neglected. Sure, there is more risk. But in the long run behavioral economics rose triumphantly.  Similarly, in the long run, evolutionary thinking will not be denied its due place in economics. For rising scholars, this is an opportunity.

A credible indicator that I view this as an intellectual opportunity is that a large fraction of my recent papers is about cultural evolution and finance. This includes my Presidential Address to the American Finance Association,⁹ a model of social transmission of trading behavior,¹⁰ a model of social belief transmission and overconsumption,¹¹ and others.

I am of course far from the only one diving into the fray. The distinguished financial economist Andrew Lo has written a book on evolution and finance,¹² as well as several research papers. Furthermore, the recent think pieces and empirical work by Nobel Laureate Robert Shiller on narratives in economics^13,14 are really about cultural evolution.

I’m based in the finance department in a business school. With regard to teaching in finance departments, my impression is that coverage of evolutionary concepts is minimal. But then, some years ago coverage of behavioral finance was minimal! This is an opportunity for rising scholars as well.

Evolutionary thinking is rapidly spreading in economics. The field of evolutionary game theory is well-established. The spread of evolutionary thinking is also reflected in thriving research on the evolution of preference and norms¹⁵ and the work of my UCI colleague Jean-Paul Carvalho), and evolutionary interpretations of economic history).¹⁶

Evolutionary thinking will continue to spread because it is a fundamental, yet in many fields of economics still largely neglected, underpinning. It is a key underpinning in two ways. First, the field of behavioral economics is founded on the psychological bias of market participants. A deeper understanding of such bias requires an understanding of the evolutionary forces that shaped the human mind.  The second is that economic behavior is a cultural phenomenon. So to understand the distribution of the traits that influence economic beliefs and behaviors, we need to understand the cultural evolutionary process that shapes that distribution.

One tip for marketing evolutionary thinking to other scholars is (at least part of the time) to derive results that speak to problems and issues that have been viewed as “mainstream” for the field. It is hard enough for people to learn and accept a novel paradigm under the best of circumstances. It is even harder when the proponents are using it to address applications that are not commonly viewed as central. It makes it easier for people to say, “That issue is not interesting,” or “That topic sounds interesting enough, but I don’t work on that.” This may be one part of why evolutionary approaches to asset pricing have been largely a separate intellectual lineage from the rest of the asset pricing field.

These approaches have disproportionately focused on such issues as chaotic dynamics, market microstructure, volatility dynamics, and power laws.  All of these are legitimate issues, and indeed some have received substantial attention from other finance scholars. Nevertheless, much of this diverges from major topics of asset pricing research—such issues as household finance (explaining the trading patterns of investors), return serial correlation, return predictability based on security characteristics, and the role of common factors in return predictability.  Even on the topic of bubbles, the focus of evolutionary finance on chaotic dynamics is sufficiently distant from the other properties of bubbles studied by other financial economists that the two literatures have not merged.

In a review paper,¹⁷ evolutionary biologist Erol Akcay and I argue that in fact, evolutionary thinking has much to say about “standard” issues of interest to most financial economists, as well as novel issues. We argue that how new evolutionary finance, using new modeling approaches, is starting to bring evolutionary thinking to bear on a broader set of issues in finance.

A final piece of advice is, when the cost/benefit balance permits, to take advantage of opportunities for interdisciplinary interaction. This includes participating in conference meetings, such as the Cultural Evolution Society; meeting with evolutionary biologists or anthropologists at one’s home institution to discuss topics of mutual interest, and coauthorship with scholars in other fields.

On all these counts, I practice what I preach. I recently was fortunate enough to work with evolutionary biologists and a mathematician on a paper now published in a biology journal, and have two further working papers on economic topics (one being on risk-taking behavior by firms)¹⁸ coauthored with two other evolutionary biologists. I have been unusually lucky in my interdisciplinary collaborators. But there is a large pool of extremely talented scholars in other fields who are willing—even eager -- to collaborate with economists on interesting issues.

References:

(1) Dawkins, Richard (2006). The Selfish Gene (30th anniversary ed.). Oxford: Oxford University Press. ISBN 978-0-19-929115-1.

(2) Sober, Elliott; Wilson, David Sloan (1998). Unto Others: The Evolution and Psychology of Unselfish Behavior. Harvard University Press. ISBN 978-0674930476.

(3) Nowak, Martin A., (2006), Evolutionary Dynamics: Exploring the Equations of Life, First Edition, Belknap Press: An Imprint of Harvard University Press.

(4) Steven A. Frank, Natural selection. I. Variable environments and uncertain returns on investment, Journal of Evolutionary Biology, 2011, 24, 11, 2299-2309, September.

(5) Peter J. Richerson and Robert Boyd, Not by Genes Alone: How Culture. Transformed Human Evolution. Chicago: University of Chicago Press (2005).

(6) Hirshleifer, Jack. (1977). “Economics from a Biological Viewpoint,” Journal of Law and Economics 20 (1), 1-52.

(7) Hirshleifer, Jack. “Natural Economy versus Political Economy,” 1978, Journal of Social and Biological Structures. 1, pp. 319-337.

(8) Hirshleifer, Jack. (1987). “On the emotions as guarantors of threats and promises.” In J. Dupré (Ed.), The Latest on the Best: Essays on Evolution and Optimality (p. 307–326). The MIT Press.

(9) Hirshleifer, David, Presidential Address: Social Transmission Bias in Economics and Finance, Journal of Finance, Volume 75, Issue 4, August 2020, 1779-1831.

(10) Bing Han, David Hirshleifer, and Johan Walden, Social Transmission Bias and Investor Behavior, Journal of Financial and Quantitative Analysis, forthcoming.

(11) Bing Han, David Hirshleifer, and Johan Walden, Visibility Bias in the Transmission of Consumption Beliefs and Undersaving (May 29, 2019). Rotman School of Management Working Paper No. 2798638, https://ssrn.com/abstract=2798638

(12) Lo, Andrew (2019). Adaptive Markets: Financial Evolution at the Speed of Thought. Princeton University Press. Princeton, NJ.

(13) Robert J. Shiller, Narrative Economics: How Stories Go Viral and Drive Major Economic Events, Princeton University Press, 2019, Princeton, NJ

(14) Shiller, Robert J., Popular Economic Narratives Advancing the Longest U.S. Economic Expansion 2009-2019 (March 9, 2020). Cowles Foundation Discussion Paper No. 2223, Available at SSRN: https://ssrn.com/abstract=3551218 or http://dx.doi.org/10.2139/ssrn.3551218

(15) Alberto Bisin and Thierry Verdier, The Economics of Cultural Transmission and the Dynamics of Preferences, Journal of Economic Theory, Volume 97, Issue 2, April 2001, Pages 298-319

(16) Nunn Nathan. History as Evolution. Working Paper. Harvard University  

(17) Erol Akcay and David Hirshleifer, New Evolutionary Finance: Social Transmission Bias and Cultural Evolution in Financial Markets, August 2020, working paper.

(18) David Hirshleifer and Joshua Plotkin, Moonshots, Investment Booms, and Selection Bias in the Transmission of Cultural Traits, Working paper, University of California, Irvine, 2020, May