Darwinian Adverse Selection

TL;DR

This paper presents a model demonstrating that rational agents in economic and biological contexts are eliminated over time due to competitive pressures, leading to a dominance of irrational strategies that are less vulnerable to collective risks.

Contribution

It introduces a novel model showing how rationality is undermined by competition, resulting in the emergence of irrational agents as the dominant strategy in equilibrium.

Findings

Rational agents are eliminated by competitive forces.

Irrational agents form a stable equilibrium distribution.

Rational coordination increases vulnerability to risks.

Abstract

We develop a model to study the role of rationality in economics and biology. The model's agents differ continuously in their ability to make rational choices. The agents' objective is to ensure their individual survival over time or, equivalently, to maximize profits. In equilibrium, however, rational agents who maximize their objective survival probability are, individually and collectively, eliminated by the forces of competition. Instead of rationality, there emerges a unique distribution of irrational players who are individually not fit for the struggle of survival. The selection of irrational players over rational ones relies on the fact that all rational players coordinate on the same optimal action, which leaves them collectively undiversified and thus vulnerable to aggregate risks.