There are various hypotheses, but the “aquatic ape” idea is the least popular amongst palaeoanthropologists. This Straight Dope entry seems an adequate summary of the main suggestions (and saves me having to write one myself :))
>We’re sexier with no hair. Charles Darwin was one of the first to suggest this, although he didn’t put it so bluntly. He merely noted that hairlessness may have been a factor in sexual selection and that women, historically the object rather than the initiator of pursuit, have less hair than men. Many later scientists have suggested variations on this theme. However, it can’t be the entire explanation. While nakedness may increase lust, a fat lot of good that does you if the other party has frozen to death.
Lack of hair makes it easier to cool off. Since it’s generally agreed humankind originated in tropical Africa, this is plausible — indigenous inhabitants of tropical regions typically wore minimal clothing before being overtaken by modernity. Zoologist Desmond Morris, author of the 1967 best seller The Naked Ape, offers the twist that hairlessness prevented hominid hunters from overheating when chasing game, which also makes sense; as distance runners we have few equals among mammals. But again, that surely isn’t the whole story, as we shall see.
Humans are descended from aquatic apes. The idea is that hairlessness made our seafood-loving forebears more streamlined in the water. There’s little evidence supporting this much-promoted notion, and scientists have roundly rejected it.
Less hair = fewer bugs, or to put it more formally, hairlessness reduces “parasite load.” Another unpersuasive claim: notwithstanding their paucity of hair, humans have largely been infested with lice, fleas, and other parasites until recently.
If none of the above explanations will cut it, what does? Here we have to guess, since the timeline of human development is poorly understood. Our hominid ancestors began walking on two legs at least 4 million years ago, and the trend toward bigger brains began about 2 million years ago. Genetic analysis suggests hominids have been hairless for at least 1.2 million years. Clothing is much more recent — the earliest evidence for hide scraping, the most primitive form of couture, dates back just 300,000 years.
The wild card is fire, needed not just to keep the cave warm but for cooking, another critical step. Recent archaeological analysis suggests hominids were using fire as of a million years ago.
If it turns out hairlessness and mastery of fire occurred around the same time, we have a plausible sequence of events. Once they were no longer at the mercy of the elements, hominids could indulge a yen for less hirsute mates without jeopardizing their offspring.
If the tendency to hairlessness long preceded fire we have more of a puzzle, although not necessarily an insoluble one: the random genetic mutation that made hairlessness possible might have occurred in the ancient past but not expressed itself till conditions were favorable. We know, for example, that Homo erectus lived 1.8 million years ago in the Caucasus region, which had cold winters then as now. Without fire, these protohumans must have had hairy coats to survive.
Once our ancestors had acquired both fire and clothing, there was nothing to prevent nakedness from becoming dominant, and at some point the capacity to grow abundant body hair evidently was lost. When the ancestors of modern east Asians were trapped in Siberia by glaciers during the last ice age, 25,000 to 50,000 years ago, they evolved eyefolds and flatter facial features to protect against the cold. But body hair didn’t re-emerge.
Technology, in this reading, made nakedness possible, and nakedness in turn made technology indispensable. We’ve been the prisoners of our own cleverness ever since.<
http://www.straightdope.com/columns/read/3082/why-do-humans-have-so-little-body-hair