Financial markets are always changing. This is not a new idea, but rather an accepted truth about their very nature. Being the sum-total of human consensus, markets capture and distill a great deal of information about a given entity into a single number: the price. As time has progressed and technologies and economies have grown, the way in which the market prices financial assets has been evolving as well. While we can only look to the past in our efforts to understand, in posterity, why a particular sequence of events unfolded in a given way, this is by no means a perfect connection. To quote Mark Twain: “History doesn’t repeat itself, but it does rhyme.” Put into context, while there may be important information about the future behaviour of markets in the historical record, we ultimately can’t rely on the future mimicking the historical record exactly.
Ultimately, this is a consequence of the ever-changing nature of markets. A narrative of changing and evolving markets makes fertile ground for talking about analogies with the scientific theory of evolution. In the realm of Charles Darwin, an organism evolves over time by selecting for genetic compositions that lead to the highest level of fitness (or reproductive success) within a given environment. In the finance world, markets select the most effective investment techniques by rewarding investors monetarily, effectively selecting those strategies most fit to navigate the always-challenging financial waves.
As a result of our own evolutionary history, when evaluating the set of possible future outcomes in a given scenario, we (humans) often behave in a risk-averse manner. A relatively well-known cognitive bias, known as “loss aversion,” suggests that we often place undue importance on the possibility of loss, relative to a gain of the same amount. Typically, a justification of why this is true follows from evolution: in our hunter-gatherer days, loss outweighed gain, because a loss could ultimately mean death. Furthermore, the so-called “recency bias” often tethers our expectations of future events to more recent – and easily recalled – experiences, therefore enforcing an expectation of continuation of the current status-quo. Taken in tandem, these two biases don’t bode well for the current investor, with recent memories of historic market pains and looming fears of economic recession.
However, to provide an evolutionary counter to this pessimistic narrative, we can turn our attention to the North American red squirrel. While there is a tremendous depth of literature on the loss-aversion bias at work in evolutionary systems , the opposite is much more rarely seen. However, in a recent article in the scientific journal Science, researchers detailed a monumental experiment with data stretching over 31 years – and cataloguing the evolutionary fitness of over 1,000 female red squirrels – on the reproductive patterns of red squirrels in the Yukon.[i] Here, the researchers showed convincing evidence of an asymmetric fitness function, with a bias toward optimism .
Specifically, the availability of food is a prime determinant for the reproductive success of squirrels, and a high availability of food provides a healthy environment for the squirrels to have a larger group of offspring. In northern climates, like those the squirrels reside in, several ‘normal’ years of relative scarcity in food are periodically punctuated by more rare mast years, where there is an excess of available nutrition. In these specific mast years, it is beneficial for the squirrels to increase their reproductive rate and produce a larger number of offspring. However, the decision of how many children to bear for a female needs to be made early in the season before it is clear what food patterns will emerge. For a loss-averse squirrel, the optimal reproductive decision will be determined by a pessimistic assumption of a non-mast (food-scarce) year. However, as the researchers discovered, there is an evolutionary advantage – in terms of future population persistence – for an optimistic take on the world: squirrels that were optimistic, and more likely to err on the side of producing more offspring in non-mast years, showed higher levels of fitness long term. Ultimately, this has to do with their lower chance of making the most costly mistake of missing out on the opportunity of taking part in a mast year food surge.
Simply, this means that those squirrels who acted as though the environment would be favourable for their reproduction fared better than those squirrels that took the opposite stance. While maybe seeming a rather foreign finding to the world of finance, it’s worth keeping the squirrel in mind. We are primed to loss-aversion in our own lives, but the benefit of this reaction is not universal. There are certainly many examples of downside risks which outweigh the upside potential, but at least the unassuming red squirrel shows us that optimism can, on occasion, win the day. While we sit at a truly unique time in the financial world, maybe it will turn out that a little optimism about the future will pay dividends over the long run.
 A. Hintze, R. S. Olson, C. Adami, & R. Hertwig, “Risk Sensitivity as an Evolutionary Adaptation”, Scientific Reports, 2015, 5, 8242
 L. Petrullo, S. Boutin, J. E. Lane, A. G. McAdam, & B. Dantzer, “Phenotype-environment mismatch errors enhance lifetime fitness in wild red squirrels”, Science, 2023, 379, 269-272
[i] The authors of this study come from a diverse set of backgrounds, from the University of Michigan, Ann Arbor, the University of Colorado Boulder, as well as a few semi-locals, from the University of Alberta (S. Boutin), and the University of Saskatchewan (J. E. Lane)
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