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The Fight to Inspire Robust Research: Dimensional Steps Up

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"One should hardly have to tell academicians that information is a valuable resource: knowledge is power. And yet it occupies a slum dwelling in the town of economics."

-- George Stigler, "The Economics of Information."

In 1961, University of Chicago professor George Stigler wrote a scathing research piece in the Journal of Political Economy, deriding his fellow academics for failing to seize on new technologies and science to refine their studies of financial markets. 

The article ("The Economics of Information") helped advance a more rigorous and systematic approach to studying stock prices and investment portfolios. A few years later, University of Chicago professor Eugene Fama made a leap forward in adding a level of precision to measuring markets that influenced a whole new generation of analysis.

"Gene Fama has been the most prominent empiricist in finance for 50 years," wrote professors G. William Schwert and Rene Stulz in their 2014 paper, "Gene Fama's Impact: A Quantitative Analysis. "He is the founder of empirical research in modern finance."

Fama certainly wasn't alone. Pioneering work by other academics such as Harry Markowitz, Merton Miller and Kenneth French applied technological advances with data-driven science to "observe order, not chaos" in how markets function, wrote John Cochrane and Tobias Moskowitz in their book "The Fama Portfolio: Selected Papers of Eugene F. Fama." The authors added: "Taken for granted now, framing price behavior in terms of responses to information was a crucial breakthrough in thinking that permeates modern financial economics." 

Against such a backdrop, Dimensional Fund Advisors has been supporting different research projects and awards aimed at promoting academic rigor. Since opening its doors in 1981, the fund company has sponsored independent studies digging deeper into issues related to everything from asset-pricing models and asset-class performance to factor premiums. 

Stepping Up

Along those lines, earlier this year three different sets of researchers were awarded with the Dimensional Fund Advisors Prizes. Winning papers were selected by the editors of The Journal of Finance from those nominated by the academic publication's associate editors. 

"For nearly 40 years, Dimensional has been taking the great ideas in financial science and applying them to real-world portfolios," Dimensional Co-CEO and Chief Investment Officer Gerard O'Reilly said in a statement. "We are proud to support pioneering research and congratulate this year's recipients on their achievements."

Top Research Papers

The prizes, which are awarded annually, cover papers published in 2019 by The Journal of Finance. Here's a brief recap of each paper:

In this paper, Hartzmark and Solomon build on a concept dating back to the early 1960s called the Dividend Irrelevance Theory. According to such a premise, investors should be generally indifferent between receiving $1 in dividends or selling $1 of shares if a company returns cash to investors (absent specific transactional and tax issues). The thesis is fairly straightforward since issuing of a dividend is going to be reflected in the price of those shares. Data presented by this paper highlights that investors too often treat dividends differently from capital gains. Such a disconnect can't be explained by taxes and transaction costs, according to the authors, and reflects the (irrational) mental accounting errors investors make.  

  • "Distinguished Paper" honorees selected by The Journal of Finance included Jules H. van Binsbergen and Christian C. Opp for "Real Anomalies." 

This paper looks at how asset pricing anomalies, possibly due to mispricing and informationally inefficient markets, lead to distortions in the allocation of resources in the real economy. Interestingly, these authors claim that their methodology can also be used by those who think prices are rational by applying such a research framework to study how risk factors in asset markets impact real economic activity.  

These two researchers take a more theoretical than empirical approach to examining variabilities in equity prices. They use information from option prices to derive the expected return of a stock. In particular, Martin and Wagner explore three types of data: the risk-neutral variance of the market; the risk-neutral variance of the individual stock; and the value-weighted average of the stock's risk-neutral variance. Then, they compare their forecasts of the expected returns on stocks in excess of the market return to the predictions of the Capital Asset Pricing Model. Such a process leads to a conclusion that their model does well compared to the CAPM. (It's worth noting these researchers aren't relying on the CAPM, rather developing an options-based model to determine the expected return on stocks.) 

Besides these awards through The Journal of Finance, Dimensional also sponsors the Fama-DFA Prize, awarded annually since 1997 to the top two papers in the areas of capital markets and asset pricing published in The Journal of Financial Economics, another leading academic journal.

Separately, Dimensional also sponsors the AIM Investment Conference, a biannual academic conference organized by the AIM Investment Center at the University of Texas at Austin, as well as the AIM Investment Center Best Paper Award, which is chosen from the papers presented at that event by conference participants.

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