Fama Nobel_16x9

A Look Back at Eugene Fama's 2013 Nobel Prize in Economics

Fama Nobel_16x9

As we approach the three year anniversary of Professor Eugene Fama winning the Nobel Prize in Economic Sciences, we thought it worthwhile to call attention to this article by his colleague at the University of Chicago Booth School of Business and son-in-law, Professor John H. Cochrane. It does a truly excellent job of summarizing Fama’s contributions to Finance, beginning with market efficiency and continuing with the development of asset pricing models and empirical methods that have become the gold standard in the field. Cochrane provides four essential reasons to justify Fama being awarded the prize:

1)      Empirical Character. Fama’s ideas have immediate real world applications. In fact, there is a whole company (Dimensional Fund Advisors) that is devoted to implementing Fama’s ideas, and has achieved great success with about $418 billion of assets under management as of December 31st, 2015.

2)      Ideas are Alive. The multifactor asset pricing models developed with his longtime collaborator Ken French remain the baseline for research in finance conducted to this day. Few other Nobel-Prize-winning ideas from several decades ago remain areas of active research.

3)      Practical Importance. Fama’s work on market efficiency resulted in the creation of index funds and exchange traded funds, which as of the end of 2015, incorporated about $4.3 trillion of the total of $18.1 trillion of Investment Company net assets, according to the 2016 Investment Company Factbook (see page 9 and 95). IFA has extensively documented the on-going migration from active to passive.

4)      Influence in the Field. Most of the founding generation of finance researchers got their PhD’s under Fama, and he has played a central role in maintaining the thought leadership position of the University of Chicago Booth School of Business. One key way he has accomplished this is through his role as Chairman of the Board of Directors at the Center for Research in Security Prices.

When advocating the idea of market efficiency, academics like Cochrane are often accused of talking their book. To this criticism, Cochrane offers an excellent retort: “In fact, a profession that earns its salary teaching MBA students could ask for no better result than to find that better knowledge and training lead to better investment management. Too bad the facts say otherwise.” Another common criticism of market efficiency is its “failure” to account for the impact of behavioral investing as seen in the domination of the market by fads such as Internet companies in the late 1990s or home construction companies up through 2007. The problem with this, according to Cochrane, is that a fad is not a testable scientific hypothesis—it is just a name for something you don’t understand. The hallmark of Fama’s conclusions is that they are testable.

To summarize, after reading Cochrane’s summary of Fama’s contributions to finance, you will probably be left with this question for the Nobel Committee: “What took you guys so long?”

Here are some Eugene Fama videos: