Nobel laureate: Eugene Fama

His development and promotion of the Efficient Market Hypothesis revolutionized our understanding of security markets and how assets should be managed

Paul Kaplan 15 January, 2019 | 6:00PM
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I’m Paul Kaplan, research director at Morningstar Canada.

In their press release regarding the 2013 Nobel Prize in Economic Sciences, the Nobel committee wrote: “Beginning in the 1960s, Eugene Fama and several collaborators demonstrated that stock prices are extremely difficult to predict in the short run, and that new information is very quickly incorporated into prices. These findings not only had a profound impact on subsequent research but also changed market practice. The emergence of so-called index funds in stock markets all over the world is a prominent example.”

While the Nobel committee’s summary of Fama’s contribution is quite terse, the Efficient Market Hypothesis has a long and rich history which is discussed in detail in chapter 1 of Andrew Lo’s book Adaptive Markets which I summarize in an article that you get to from the link provided to right of the video screen. Here, I present some of the highlights.

In 1900, a Ph.D. student at the Sorbonne in Paris, Louis Bachelier, published his doctoral thesis in which he should showed that changes in stock prices are unpredictable, thus anticipating a key feature of the Efficient Market Hypothesis. Unfortunately, Bachelier’s work remained in obscurity until it was accidently rediscovered by the statistician Leonard J. Savage in 1954 at the University of Chicago. He wrote to colleagues, including MIT’s Paul Samuelson. According to Lo, Savage’s letter to Samuelson changed the course of financial history. Samuelson explained why prices follow random walks. All information from past prices are embodied in current price as is all relevant information. So future price changes cannot be predicted based on any information today. (Samuelson was awarded the Nobel prize in 1970 for his many other contributions to economics.)

Almost simultaneously, Fama independently discovered the Efficient Market Hypothesis as a result of his statistical analysis of stock prices. Later, Fama broke down the Efficient Market Hypothesis into three versions:

1) Weak-form. In a weak-form efficient market, current prices reflect all information contained in past prices. Hence, trying to beat the market using “technical analysis” of past prices is futile.

2) Semistrong-form. In a semistrong-form efficient market, current prices reflect all publicly available information. Hence, strategies based on any publicly available information are futile.

3) Strong-form. In strong-form efficient market, all information, public and private is reflected in current prices. Hence, trading on insider information is futile.

The Efficient Market Hypothesis is a bedrock concept of financial economics. Active management can only be justified if it can be demonstrated there are security markets lack the efficiency that Fama described. For his groundbreaking contributions to formulating the Efficient Market Hypothesis, Eugene Fama richly deserved his share of the 2013 Nobel Prize in Economic Sciences.


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Paul Kaplan

Paul Kaplan  Paul Kaplan is Director of Research for Morningstar Canada.

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