  Standard approaches to the theory of financial markets are based on
equilibrium and efficiency. Here we develop an alternative based on concepts
and methods developed by biologists, in which the wealth invested in a
financial strategy is like the abundance of a species. We study a toy model of
a market consisting of value investors, trend followers and noise traders. We
show that the average returns of strategies are strongly density dependent,
i.e. they depend on the wealth invested in each strategy at any given time. In
the absence of noise the market would slowly evolve toward an efficient
equilibrium, but the statistical uncertainty in profitability (which is
adjusted to match real markets) makes this noisy and uncertain. Even in the
long term, the market spends extended periods of time away from perfect
efficiency. We show how core concepts from ecology, such as the community
matrix and food webs, give insight into market behavior. The wealth dynamics of
the market ecology explain how market inefficiencies spontaneously occur and
gives insight into the origins of excess price volatility and deviations of
prices from fundamental values.
