Why Eugene Fama should get a Nobel prize

13th October, 2008

I read this light-hearted essay on the Today program on the morning of 13th October.

Someone recently grumbled to me that, given the appalling state of the world’s financial system, nobody should be awarded today’s Nobel memorial prize for economics. That’s a little harsh: some economists did warn us of trouble on the horizon.
Still, Nobel-watchers think that this will not be the year that the prize is given to a man called Eugene Fama. Fama, a Professor at the University of Chicago and a long-time contender for the prize, is best known as the man who believes that financial markets are efficient. The timing would seem awkward.
I think that’s a shame. The belief that financial markets are efficient sounds like some Thatcherite creed, but it means something quite different: that the price of shares today reflects everything we currently know about their value. There are no obvious bargains, no easy forecasts, no get-rich-quick schemes.
More of us ought to know about Eugene Fama’s ideas. We’d learn that trying to spot a good value share or to make a killing with a buy-to-let property is a bit like trying to pick the fastest queue in the supermarket. If it was so obvious which was the fastest queue, people would get into it and it wouldn’t be the fastest queue for long. If Eugene Fama is right and financial markets really are efficient – and the evidence still suggests that they might be – then you and I can’t pick a brilliant investment except by blind luck.
Neither can anyone predict what the market will do tomorrow, because efficient markets already reflect everything we know. Prices change daily only because of news, not because of anything that could have been forecast yesterday. Imagine all the time we could save by ignoring the prognostications of city economists.
Investors who believe in efficient markets make more money – or perhaps I should say lose less money. They don’t pay fund managers huge fees to pick good stocks, because they don’t think fund managers can pick good stocks. They ignore advertisements touting past performance, because in an efficient market past performance tells you literally nothing about the future. They don’t try to time the market, which in practice has always meant rushing in during booms and panic selling during busts – buying high and selling low. In fact, they don’t even look at what the stock market is doing from day to day. Why bother? It won’t give you an investment edge, and it might well give you an ulcer.
So here’s hoping for a Nobel prize for Eugene Fama. The stock market may not be efficient, but it’s smarter than you and me.

The prize, of course, went to Paul Krugman. Congratulations, Professor Krugman! Professor Fama’s day will come.

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