Eugene Fama
Encyclopedia
Eugene Francis "Gene" Fama (born February 14, 1939) is an American economist, known for his work on portfolio theory and asset pricing, both theoretical and empirical. He is currently Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business.
in 1960 and his M.B.A. and Ph.D.
from the Booth School of Business at the University of Chicago
in economics
and finance
. His doctoral supervisors were Merton Miller and Harry Roberts, but Benoit Mandelbrot
was also an important influence. He has spent all of his teaching career at the University of Chicago
.
His Ph.D. thesis, which concluded that stock
price movements are unpredictable and follow a random walk
, was published in January, 1965 issue of the Journal of Business, entitled "The Behavior of Stock Market Prices". That work was subsequently rewritten into a less technical article, "Random Walks In Stock Market Prices", which was published in the Financial Analysts Journal in 1965 and Institutional Investor in 1968.
His article "The Adjustment of Stock Prices to New Information" in the International Economic Review
, 1969 (with several co-authors) was the first event study
that sought to analyze how stock prices respond to an event, using price data from the newly available CRSP
database. This was the first of literally hundreds of such published studies.
, beginning with his Ph.D. thesis. In a ground-breaking article in the May, 1970 issue of the Journal of Finance
, entitled "Efficient Capital Markets: A Review of Theory and Empirical Work," Fama proposed two crucial concepts that have defined the conversation on efficient markets ever since. First, Fama proposed three types of efficiency: (i) strong-form; (ii) semi-strong form; and (iii) weak efficiency. They are explained in the context of what information are factored in price. In weak form efficiency the information set is just historical prices, which can be predicted from historical price trend; thus, it is impossible to profit from it. Semi-strong form requires that all public information is reflected in prices already, such as companies' announcements or annual earnings figures. Finally, the strong-form concerns all information, including private information are incorporated in price; it states no monopolistic information can entail profits, in other words, insider trading cannot make a profit in the strong-form market efficiency world.
Second, Fama demonstrated that the notion of market efficiency could not be rejected without an accompanying rejection of the model of market equilibrium (e.g. the price setting mechanism). This concept, known as the "joint hypothesis problem," has ever since vexed researchers. Market efficiency denotes how information is factored in price, Fama (1970) emphasizes that the hypothesis of market efficiency must be tested in the context of expected returns. The joint hypothesis problem states that when a model yields a return significantly different from the actual return, one can never be certain if there exists an imperfection in the model or if the market is inefficient. Researchers can only modify their models by adding different factors to eliminate any anomalies, in hopes of fully explaining the return within the model. The anomaly, also known as alpha in the modeling test, thus functions as a signal to the model maker whether it can perfectly predict returns by the factors in the model. However, as long as there exists an alpha, neither the conclusion of a flawed model nor market inefficiency can be drawn according to the Joint Hypothesis. Fama (1991) also stresses that market efficiency per se is not testable and can only be tested jointly with some model of equilibrium, i.e. an asset-pricing model.
, that cast doubt on the validity of the Capital Asset Pricing Model (CAPM)
, which posits that a stock's beta alone should explain its average return. These papers describe two factors above and beyond a stock's market beta which can explain differences in stock returns: market capitalization and "value". They also offer evidence that a variety of patterns in average returns, often labeled as "anomalies" in past work, can be explained with their 3 factor model
.
, Inc., an investment advising firm with $187 billion under management .
In addition, Fama co-authored "Risk, Return, and Equilibrium: Empirical Tests" with James D. Macbeth, which describes the now widely used Fama-Macbeth two-stage regression used to price risk premia of factors.
.
Career
He earned his undergraduate degree in French from Tufts UniversityTufts University
Tufts University is a private research university located in Medford/Somerville, near Boston, Massachusetts. It is organized into ten schools, including two undergraduate programs and eight graduate divisions, on four campuses in Massachusetts and on the eastern border of France...
in 1960 and his M.B.A. and Ph.D.
Ph.D.
A Ph.D. is a Doctor of Philosophy, an academic degree.Ph.D. may also refer to:* Ph.D. , a 1980s British group*Piled Higher and Deeper, a web comic strip*PhD: Phantasy Degree, a Korean comic series* PhD Docbook renderer, an XML renderer...
from the Booth School of Business at the University of Chicago
University of Chicago
The University of Chicago is a private research university in Chicago, Illinois, USA. It was founded by the American Baptist Education Society with a donation from oil magnate and philanthropist John D. Rockefeller and incorporated in 1890...
in economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
and finance
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
. His doctoral supervisors were Merton Miller and Harry Roberts, but Benoit Mandelbrot
Benoît Mandelbrot
Benoît B. Mandelbrot was a French American mathematician. Born in Poland, he moved to France with his family when he was a child...
was also an important influence. He has spent all of his teaching career at the University of Chicago
University of Chicago
The University of Chicago is a private research university in Chicago, Illinois, USA. It was founded by the American Baptist Education Society with a donation from oil magnate and philanthropist John D. Rockefeller and incorporated in 1890...
.
His Ph.D. thesis, which concluded that stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
price movements are unpredictable and follow a random walk
Random walk
A random walk, sometimes denoted RW, is a mathematical formalisation of a trajectory that consists of taking successive random steps. For example, the path traced by a molecule as it travels in a liquid or a gas, the search path of a foraging animal, the price of a fluctuating stock and the...
, was published in January, 1965 issue of the Journal of Business, entitled "The Behavior of Stock Market Prices". That work was subsequently rewritten into a less technical article, "Random Walks In Stock Market Prices", which was published in the Financial Analysts Journal in 1965 and Institutional Investor in 1968.
His article "The Adjustment of Stock Prices to New Information" in the International Economic Review
International Economic Review
The International Economic Review, is a quarterly peer-reviewed scientific journal in economics published by the Economics Department of the University of Pennsylvania and Osaka University...
, 1969 (with several co-authors) was the first event study
Event study
An Event study is a statistical method to assess the impact of an event on the value of a firm. For example, the announcement of a merger between two business entities can be analyzed to see whether investors believe the merger will create or destroy value...
that sought to analyze how stock prices respond to an event, using price data from the newly available CRSP
Center for Research in Securities Prices
The Center for Research in Security Prices is a provider of historical stock market data. The Center is a part of the Booth School of Business at the University of Chicago. CRSP maintains some of the largest and most comprehensive proprietary historical databases in stock market research...
database. This was the first of literally hundreds of such published studies.
Efficient market hypothesis
Fama is most often thought of as the father of efficient market hypothesisEfficient market hypothesis
In finance, the efficient-market hypothesis asserts that financial markets are "informationally efficient". That is, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.There are...
, beginning with his Ph.D. thesis. In a ground-breaking article in the May, 1970 issue of the Journal of Finance
Journal of Finance
The Journal of Finance is a peer-reviewed academic journal published by Wiley-Blackwell on behalf of the American Finance Association. It was established in 1946. Its current editors are Campbell R. Harvey and John R. Graham...
, entitled "Efficient Capital Markets: A Review of Theory and Empirical Work," Fama proposed two crucial concepts that have defined the conversation on efficient markets ever since. First, Fama proposed three types of efficiency: (i) strong-form; (ii) semi-strong form; and (iii) weak efficiency. They are explained in the context of what information are factored in price. In weak form efficiency the information set is just historical prices, which can be predicted from historical price trend; thus, it is impossible to profit from it. Semi-strong form requires that all public information is reflected in prices already, such as companies' announcements or annual earnings figures. Finally, the strong-form concerns all information, including private information are incorporated in price; it states no monopolistic information can entail profits, in other words, insider trading cannot make a profit in the strong-form market efficiency world.
Second, Fama demonstrated that the notion of market efficiency could not be rejected without an accompanying rejection of the model of market equilibrium (e.g. the price setting mechanism). This concept, known as the "joint hypothesis problem," has ever since vexed researchers. Market efficiency denotes how information is factored in price, Fama (1970) emphasizes that the hypothesis of market efficiency must be tested in the context of expected returns. The joint hypothesis problem states that when a model yields a return significantly different from the actual return, one can never be certain if there exists an imperfection in the model or if the market is inefficient. Researchers can only modify their models by adding different factors to eliminate any anomalies, in hopes of fully explaining the return within the model. The anomaly, also known as alpha in the modeling test, thus functions as a signal to the model maker whether it can perfectly predict returns by the factors in the model. However, as long as there exists an alpha, neither the conclusion of a flawed model nor market inefficiency can be drawn according to the Joint Hypothesis. Fama (1991) also stresses that market efficiency per se is not testable and can only be tested jointly with some model of equilibrium, i.e. an asset-pricing model.
Fama-French three-factor model
In recent years, Fama has become controversial again, for a series of papers, co-written with Kenneth FrenchKenneth French
Kenneth Ronald "Ken" French is the Carl E. and Catherine M. Heidt Professor of Finance at the Tuck School of Business, Dartmouth College. He has previously been a faculty member at MIT, the Yale School of Management, and the University of Chicago Booth School of Business...
, that cast doubt on the validity of the Capital Asset Pricing Model (CAPM)
Capital asset pricing model
In finance, the capital asset pricing model is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable risk...
, which posits that a stock's beta alone should explain its average return. These papers describe two factors above and beyond a stock's market beta which can explain differences in stock returns: market capitalization and "value". They also offer evidence that a variety of patterns in average returns, often labeled as "anomalies" in past work, can be explained with their 3 factor model
Fama-French three-factor model
In asset pricing and portfolio management the Fama-French three factor model is a model designed by Eugene Fama and Kenneth French to describe stock returns....
.
Other work
Additionally, Fama co-authored the textbook The Theory of Finance with Nobel Memorial Prize in Economics winner Merton H. Miller. He is also the director of research of Dimensional Fund AdvisorsDimensional Fund Advisors
Dimensional Fund Advisors is an investment firm headquartered in Austin, Texas with regional offices in Amsterdam, Berlin, London, Santa Monica, Sydney, and Vancouver. The company was founded in 1981 by David G. Booth and Rex Sinquefield, both graduates of the University of Chicago Booth School of...
, Inc., an investment advising firm with $187 billion under management .
In addition, Fama co-authored "Risk, Return, and Equilibrium: Empirical Tests" with James D. Macbeth, which describes the now widely used Fama-Macbeth two-stage regression used to price risk premia of factors.
Awards
In 2005, Fama was the first winner of the newly established Deutsche Bank Prize in Financial EconomicsDeutsche bank prize
The Deutsche Bank Prize in Financial Economics honors renowned researchers who have made influential contributions to the fields of finance and money and macroeconomics, and whose work has led to practical and policy-relevant results. It is awarded biannually, since 2005, by the Center for...
.
External links
- Faculty profile at the University of ChicagoUniversity of ChicagoThe University of Chicago is a private research university in Chicago, Illinois, USA. It was founded by the American Baptist Education Society with a donation from oil magnate and philanthropist John D. Rockefeller and incorporated in 1890...
- Biography on Dimensional Fund Advisors website
- The Fama/French Forum – Observations, opinion, research and links from financial economists Eugene Fama and Kenneth French.
- Eugene Fama, 2005 winner of the Deutsche Bank Prize in Financial Economics