Tuesday, October 15, 2013

Fama and the Other Fama

Friendly note to all the good folks frothing at the mouth over the idea of a "Nobel" Prize for Eugene Fama: you're right.  "Markets are never wrong" Fama aka "government is never right" Fama; "I don't understand bubbles" Fama, aka "there re no bubbles" Fama--that guy deserves a "Nobel" (even a faux Nobel) about as much as Isaac Newton deserved a prize for his alchemy.

But even a blind hog finds a few acorns and really good scientists believe a lot of nutty things.  To gain perspective, I'd urge that we take a few moments to remember what markets were like back before, say, 1965--back in the age of fixed commissions, before Charles Schwab, when we really believed Your Broker was Your Friend.  And when the broker, for his part, could make a high income and a low golf handicap from saying "Oh Buce, I wouldn't sell my Penn Central."  Back, that is, when we thought that even not-very bright people with lots of Aqua Velva in the Anglican Church vestry could make a money by picking stocks.  Back, that is, before the other Eugene Fama--the young insurgent Eugene Fama--kicked the pins out of an entire  industry whose presuppositions, as it now appeared, where about as relevant as the reading of sheep's entrails.

The trouble is that there are two Famas: manic, loony, ideological Fama as set forth above and the younger, soberer twin.  The latter doesn't know anything about how markets move and takes pride in his ignorance. The former knows (or knew): look, investing is insanely competitive.  At its best it takes extraordinary skill and hard work (not to say luck) and if you go into it expecting to get fat, you are more than likely to wind up on the menu.  In short, that trying to outguess the market is like playing Russian roulette with five bullets in the magazine.

Granted, there are still plenty of hawkers investment advisers ready to say "oh Buce, I wouldn't do that"--and plenty of customers, poor souls, who are ready to listen.   But these days, the advisers know that most investors will laugh in his face.  We see things differently now.  Trying to see them the way we did before Fama (and, to be complete, Harry Markowitz) is pretty much like trying to remember what life was like before Copernicus.

Two Famas: it's a distinction worth keeping in mind.  William Shockley got the (real) Nobel for inventing the transistor.  He spent his sunset years trying to persuade his fellow laureates to pack their sperm into little bottles.  We honor the one and laugh off the other.  We could treat Fama the same way.


John M. said...

Good insight. People change as they grow. And they're often the last to notice that they've changed.

Herman said...

There are at least two problems with the "two Fama" view:

1. Fama, unlike Shockley, is talking nonsense on precisely the topic for which he has won the award.

2. Fama was spouting nonsense even when he was younger. While recent events and the fact the his contemporaries were recognized long ago might have turned Fama into a bitter old man, increasing the virulence and frequency of his nonsense, it is a fact that he was talking nonsense even when he was younger.

Here he is claiming falsely that the EMH implies allocative efficiency (Fama 1970):

' The primary role of the capital market is allocation of ownership of the economy's capital stock. In general terms, the ideal is a market in which prices provide accurate signals for resource allocation: that is, a market in which firms can make production-investment decisions, and investors can choose among the securities that represent ownership of firms' activities under the assumption that security prices at any time “fully reflect” all available information. A market in which prices always “fully reflect” available information is called “efficient.” '

Wonks Anonymous said...

Is the Fama of Fama-French 3 Factor model the young (good) one or the old (bad) one?