Eugene Fama Awarded The Nobel Prize In Economics 2013

Fred had another interesting commentary on Eugene Fama:

Date: Mon, 14 Oct 2013 16:01:54 -0400

One of the real pleasures in life is to be able to have both one’s opinions vindicated but also having the ability to say: “I told you so!” Back in 1993 or ’94, I predicted that Fama would receive his Nobel Prize within the next five years. Well, I was right — but just a little off on the timing of when his important contribution to the world of financial economics would be recognized. However, now I have the pleasure of saying: I told you so!

As many who have read my ongoing Commentaries, books and papers are aware, I have often referred to Professor Fama (U. of Chicago) and his seminal works: “Efficient Market Hypothesis” and “The Three Factor Model” (co-researched with Prof. Kenneth French). His work, now joins two other Nobel Laureates whose work we utilize as foundational building blocks for our portfolios (Harry Markowitz [Modern Portfolio Theory] and the late Merton Miller [Cost of Capital]).

As I have outlined in my latest paper: “Free Market Investing — A Winning Investment Strategy” (which most clients and readers may have received a copy of. If not, it is available simply for the asking) — the basic theories and research of these three Nobel Laureates, while supported by some fairly sophisticated and complex mathematics and statistical analyses, is not all that difficult for investors to comprehend. This is not “secret knowledge,” just as the secret to losing weight isn’t. However, it runs up against our very own human nature which makes it difficult to utilize. We all possess more than enough ego to think that we are smart enough to succeed where others — including many far smarter than we — have failed and, of course, one of the greatest of human failings: hubris!

I have been more than fortunate in my professional career to have been associated with some of the giants of the investment firmament such as: Sir John Templeton, Phillip Carret, Max Heine and several others. In establishing my marriage with Matrix (now MatsonMoney), I came into direct contact with both Fama-French and Merton Miller. These individuals along with the influence of Harry Markowitz changed my investment life from one of searching for the next greatest idea (which is a pipe dream at best) or style, to a far more truly scientific approach to investing — one that has provided substantial and consistent success for both me and our investors over the years.

(Important caveat here that the regulators require: “Past performance is no guarantee of future performance)

 I hope that with this award, those who are clients and/or readers of my works will fully appreciate just how important the work of not only the newest recipient is, Fama, but also the others upon whom we rely in order to achieve the best possible long-term investment results.

Congratulations to Professor Fama as well as the other two recipients of this prestigious award — while a long time coming (for Fama), it is more than well deserved!

 

News of the announcement, from today’s Wall Street Journal below (emphasis is mine):

U.S. News

Americans Win Economics Nobel For Market Insights

Scholars Fama, Hansen and Shiller Share Award
By Brenda Cronin and Niclas Rolander

Three American scholars swept the Nobel Prize in economics Monday, for pioneering research in the workings of financial markets, asset prices and behavioral economics.

Americans Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller won the Nobel prize for economics. Brenda Cronin joins MoneyBeat to discuss their legacy.

The Royal Swedish Academy of Sciences in Stockholm honored Eugene Fama and Lars Peter Hansen of the University of Chicago and Robert Shiller of Yale, citing the trio’s “empirical analysis of asset prices.”

Messrs. Fama, Shiller and Hansen, who have researched separately how stocks and bonds are priced and why, won for advances that have reshaped portfolio management, given rise to the index fund and created a fundamental tool used in econometric analysis.

Mr. Fama, the senior member of the trio, is seen by many as the father of modern finance, for his 1960s-era work on the theory of efficient markets. Mr. Fama—after meeting with little success in stock-picking—found that when markets work well, asset prices reflect all the latest information. Hence, attempts to profit by picking stocks or timing the market were often fruitless. Those findings helped spark an industry of index funds.

However, two decades later, Robert Shiller found that markets’ short-term efficiency was less enduring over time. Instead, asset prices appeared to be much too volatile to be justified by fundamental information, such as dividends. In short, Mr. Shiller learned that prices moved for a host of reasons, many of them not necessarily rational.

Mr. Hansen, in trying to test for market predictability, developed a widely used econometric tool. His Generalized Method of Moments is used for running regression analyses, which economists tap to uncover relationships among variables.

Speaking Monday to reporters in Stockholm by telephone from New Haven, Conn., Mr. Shiller expressed his reaction to the award as “disbelief.”

“I was attracted to economics because it deals with really important problems,” he said. “Finance drew me in because it’s so fundamental to human activity. It follows precise mathematical relations but there’s an element of imprecision that reflects human nature.”

Monday’s recognitions add three more U.S.-based experts to the group of 2013 Nobel recipients honored for the fruits of their research. Three U.S.-based scientists were awarded the Nobel Prize in medicine last Monday, and three more U.S.-based scientists won the Nobel Prize in chemistry two days later.

The economics award, which comes on the heels of a week of Nobel honors in physics, medicine, chemistry, literature and peace, isn’t one of the original prizes, which have been conferred since 1901. The economics award, initiated by Sweden’s central bank in 1968, is known as the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.

The prize tallies about 8 million Swedish kroner ($1.2 million), which will be divided among the winners.

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There was a follow on article that essentially claimed that while Fama and Shiller were “strange bedfellows,” because Shiller predicted the bubbles of the dot.com era and that of the more recent real estate, Shiller was more relevant to many today because of his ability to “predict.” I disagree with this conclusion and wrote a brief response in today’s Wall Street Journal online edition:
The conclusion of the article misunderstands Fama’s hypothesis. Essentially it is that everything that is known about a stock, asset class or market is factored into the price TODAY! Whether “rational” or “irrational,” the only thing that can move that stock, asset class or market is what is unknown — basically tomorrow’s news.

The esteemed Prof Shiller has no better idea as to what the “herd” is going to do in the future, whether tomorrow, next month, year or decade.

Insofar as predicting or calling “bubbles,” is concerned, many like prof Shiller were correct and put their money where their mouths were. Unfortunately for them, they were early and got wiped out before the bubble(s) burst. It is one thing to predict. It is another to be able to predict accurately when one is not dealing in theory, but rather, with real money! In the real world of investing, it is not sufficient to be able to predict, one has to be able to predict not only  accurately in “real time” but also while investment decisions are being made. This brings us to the market timing aspects of predictions and all truly knowledgeable investors and professionals understand the fallacy of that game!
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Frederick C. Taylor
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