Eugene Fama

From Wikipedia, the free encyclopedia

Eugene Fama
Eugene Fama (left) winning the inaugural Morgan Stanley-American Finance Association Award
Born	February 14, 1939 (1939-02-14) (age 69) Boston, Massachusetts
Residence	U.S.
Nationality	American
Fields	Financial economics
Institutions	University of Chicago Graduate School of Business (c.1960-)
Alma mater	University of Chicago Graduate School of Business (M.B.A., Ph.D.) Tufts University (A.B.)
Doctoral advisor	Merton Miller
Notes Websites: Home page Dimensional Fund Advisors

Eugene F. "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 earned his undergraduate degree in French from Tufts University in 1960 and his MBA and Ph.D. from the Graduate School of Business at the University of Chicago in economics and finance. 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" (Page 34-105). That work was subsequently rewritten into a less technical article, "Random Walks In Stock Market Prices"^[1], 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.

Fama is most often thought of as the father of efficient market hypothesis. 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: (1) strong-form; (ii) semi-strong form; and (iii) weak efficiency. 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.

In recent years, Fama has become controversial again, for a series of papers, co-written with Kenneth French, 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.

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 Advisors, Inc., an investment advising firm with $126 billion under management (as of 2006). One of his children, Eugene F. Fama Jr., is a vice president of the company.

In 2005, Fama was the first winner of the newly established Deutsche Bank Prize in Financial Economics.^[2]

Contents 1 Fama and French Three Factor Model 2 Bibliography 3 References 4 External links

[edit] Fama and French Three Factor Model

It has been suggested that this section be split into a new article entitled Fama-French Three Factor Model. (Discuss)

In the portfolio management field, Fama and French developed the highly successful three factor model to describe the market behavior.

CAPM uses a single factor, beta, to compare the excess returns of a portfolio with the excess returns of the market as a whole. But it oversimplifies the complex market. Fama and French started with the observation that two classes of stocks have tended to do better than the market as a whole: (i) small caps and (ii) stocks with a high book-to-market ratio (BM, customarily called value stocks; to be differentiated from growth stocks). They then added two factors to CAPM to reflect a portfolio's exposure to these two classes ^[3]:

Here r is the portfolio's return rate, R_f is the risk-free return rate, and K_m is the return of the whole stock market. The "three factor" β is analogous to the classical β but not equal to it, since there are now two additional factors to do some of the work. SMB and HML stand for "small [Market Capitalization] minus big" and "high [book-to-price ratio] minus low"; they measure the historic excess returns of small caps over big caps and "value stocks" over "growth stocks". It is important to note that these factors are calculated with combinations of portfolios composed by ranked stocks (BM ranking, Cap ranking) and available historical market data. By the way, you may find their historical values in Kenneth French's web page. Moreover, SMB and HML are defined, the corresponding coefficients bs and bv are determined by linear regressions and can take negative values as well as positive values. Intuitively, one would expect a portfolio of Big Caps to have a negative bs coefficient, a portfolio of value stocks to have a positive bv coefficient, etc. The Fama-French Three Factor model explains over 90% of the diversified portfolios returns, compared with the average 80% given by the CAPM. The signs of the coefficients suggested that small cap and value portfolios have higher expected returns--and arguably higher expected risk--than those of large cap and growth portfolios.^[4]

The three factor model is gaining recognition in portfolio management. Morningstar.com classifies stocks and mutual funds based on these factors. Many studies show that the majority of actively managed mutual funds underperform broad indexes based on three factors if classified properly. This leads to more and more index funds and ETFs being offered based on the three factor model.

[edit] Bibliography

Presented in chronological order

1. "Mandelbrot and the stable Paretian Hypothesis," [1]Journal of Business (October 1963); reprinted in Paul Cootner(ed.), The Random Character of Stock Prices (MIT Press, 1964).

2. "The Behavior of Stock Market Prices," [2] Journal of Business(January 1965).

3. "Portfolio Analysis in a Stable Paretian Market," Management Science (January 1965).

4. "Tomorrow on the New York Stock Exchange," [3] Journal of Business (July 1965).

5. "Random Walks in Stock Market Prices," [4] paper number 16 in the series of Selected Papers of the Graduate School of Business, University of Chicago, reprinted in the Financial Analysts Journal (September-October 1965), The Analysts Journal, London (1966), The Institutional Investor, 1968.

6. "Filter Rules and Stock Market Trading Profits" [5](with Marshal Blume), Journal of Business, Supplement (January 1966).

7. "Solutions for Cash Balance and Simple Dynamic Portfolio Problems," [6] (with Gary Eppen), Journal of Business (January 1968).

8. "Some Properties of Symmetric Stable Distribution" (with Richard Roll), Journal of the American Statistical Association(January 1968).

9. "Risk, Return, and General Equilibrium: Some Clarifying Comments," [7]Journal of Finance (March 1968).

10. "Dividend Policy of Individual Firms: An Empirical Analysis" (with Harvey Babiak), Journal of the American Statistical Association (December 1968).

11. "Risk and the Evaluation of Pension Fund Portfolio Performance," Administration Institute, Park Ridge, Illinois, 1968.

12. "The Adjustment of Stock Prices to New Information" [8] (with L. Fisher, M. Jensen, and R. Roll), International Economic Review February 1969).

13. "Cash Balance and Simple Dynamic Portfolio Problems with Proportional Costs," [9](with Gary Eppen), International Economic Review(June 1969).

14. "Multi-Period Consumption-Investment Decisions," [10]American Economic Review(March 1970).

15. "Efficient Capital Markets: A Review of Theory and Empirical Work," [11]Journal of Finance (May 1970).

16. "Three Asset Cash Balance and Dynamic Portfolio Problems" (with Gary Eppen), Management Science (January 1971).

17. "Risk, Return, and Equilibrium," Journal of Political Economy (January-February 1971).

18. "Parameter Estimates for Symmetric Stable Distribution" (with Richard Roll), Journal of the American Statistical Association] (June 1971).

19. "Information and Capital Markets" (with Arthur Laffer), Journal of Business (July 1971).

---

20. The Theory of Finance (with Merton Miller). (Holt, Rinehart and Winston, 1972). These hyperlinks are available directly from Eugene Fama's home page.

The Theory of Finance Preface and Table of Contents

Chapter 1 A Model of the Accumulation and Allocation of Wealth by Individuals

Chapter 2 Extension of the Model to Durable Commodities Production

Chapter 3 Criteria For Optimal Investment Decsions

Chapter 4 Financing Decisions, Investment Decisions, and the Cost of Capital

Chapter 5 The Expected Utility Approach to the Problem of Choice under Uncertainty

Chapter 6 The Two Period Consumption Investment Model

Chapter 7 Risk, Return, and Market Equilibrium

Chapter 8 Multiperiod Models

---

21. "Ordinal and Measurable Utility." In Studies in the Theory of Capital Markets, edited by Michael Jensen. New York: Praeger, 1972.

22. "Components of Investment Performance," Journal of Finance (June 1972).

23. “The Number of Firms and Competition” (with Arthur Laffer), American Economic Review (September 1972).

24. “Perfect Competition and Optimal Production Decisions and Uncertanity,” Bell Journal of Economics and Management Science (autumn 1972).

25. “Risk, Return, and Equilibrium: Empirical Tests” (with J. Macbeth), Journal of Political Economy (May-June 1973).

26. “A Note on the Market Model and the Two-Parameter Model,” Journal of Finance (December 1973).

27. “Tests of the Multiperiod Two-Parameter Model” (With J. Macbeth), Journal of Financial Economics (March 1974).

28. “Long-Term Growth in a Short-Term Market” (with J. Macbeth), Journal of Finance (June 1974).

29. "The Empirical Relationship between the Dividend and Investment Decisions of Firms," American Economic Review (June 1976).

30. “Short-Term Interest Rates as Predictors of Inflation,” American Economic Review (June 1975).

---

31. Foundation of Finance (New York: Basic Book, 1976). These hyperlinks are available directly from Eugene Fama's home page.

PREFACE

Chapter 1 The Behavior of Stock Market Returns

Chapter 2 The Distribution of the Return on a Portfolio

Chapter 3 The Market Model Theory and Estimation

Chapter 4 The Market Model Estimates

Chapter 5 Efficient Capital Markets

Chapter 6 Short Term Interest Rates as Predictors of Inflation

Chapter 7 The Two Parameter Portfolio Model

Chapter 8 Capital Market Equilibrium in a Two Parameter World

Chapter 9 The Two Parameter Model Empirical Tests

---

32. “Inflation Uncertainty and Expected Returns on Treasury Bills.” Journal of Political Economy (June 1976).

33. “Forward Rates a Predictors of Future Spot Rates,” Journal of Financial Economics (October 1976).

34. “Human Capital and Capital Market Equilibrium” (with G. William Schwert), Journal of Financial Economics (January 1977).

35. “Interest Rates and Inflation: The Message in the Entrails,” American Economic Review (June 1977).

36. “Risk-Adjusted Discount Rates and Capital Budgeting under Uncertainty,” Journal of Financial Economics (August 1977).

37. “Asset Return and Inflation” (with G. William Schwert), Journal of Financial Economics (November 1977).

38. “The Effects of a Firms’s Investment and Financing Decisions on the Welfare of it Securityholders,” American Economic Review (June 1978).

39. "Inflation, Interest and Relative Price” (with G. William Schwert), Journal of Business (April 1979).

40. “Money, Bonds, and Foreign Exchange” (with André Farber), American Economic Review (September 1979).

41. “Banking in the Theory of Finance,” Journal of Monetary Economics (January 1980).

42. “Agency Problem and the Theory of the Firm,”Journal of Political Economy (April 1980).

43. “Stock Returns, Real Activity, Inflation and Money,” American Economic Review (September 1981).

44. “Inflation, Output and Money,” Journal of Business (April 1982).

45. “Inflation, Real Returns and Capital Investments” (with Michael Gibbson), Journal of Monetary Economics (May 1982).

46. "Separation of Ownership and Control" (with Michael Jensen), Journal of Law and Economics (June 1983).

47. "Agency Problems and Residual Claims" (with Michael Jensen), Journal of Law and Economics (June 1983).

48. "Financial Intermediation and Price Level Control," JOurnal of Monetary Economics (July 1983).

49. "A Comparison of Inflation Forecasts" (with Michael Gibbsons), Journal of Monetary Economics (May 1984).

50. "The Information in the Term Structure," Journal of Financial Economics, (December 1984).

51. "Fowrward and Spot Exchange Rates," Journal of Monetary Economics, (November 1984).

52. "Term Premiums in Bond Returns," Journal of Financial Economics, (December 1984).

53. "What's Different About Banks?," Journal of Monetary Economics, (January 1985).

54. "Organizational Forms and Investment Decisions" (with Michael Jensen), Journal of Financial Economics, (March 1985).

55. "Term Premiums an Default Premiums in Money Markets," Journal of Financial Economics, (September 1986).

56. "Commodity Future Prices" Evidence on Forecast Power and Premiums," (with Kenneth R. French), Journal of Business, (January 1987).

57. "The Information in Long-Maturity Forward Rates," (with Robert R. Bliss), American Economic Review, (September 1987).

58. "Permanent and Temporary Components of Stock Prices," (with Kenneth R. French), Journal of Political Economy ,(April 1988).

59. "Dividend Yields and Expected Stock Returns," (with Kenneth R. French), Journal of Financial Economics, 22 (October 1988), 3-25.

60. "Business Cycles and the Behaviour of Metals Prices," (with Kenneth R. French), Journal of Finance , (December 1988).

61. "Perspective on October 1987, or, What Did we learn from the Crash?" in Black Monday and the Future of Financial Markets, edited by R.W. Kamphuis, Jr.,R.C. Kormendi, and J.W.H. Watson (Homewood: Dow-Jones-Irwin, Inc.), 1989.

62. "Business Conditions and Expected Returns on Stocks and Bonds," (with Kenneth R. French), [12] Journal of Financial Economics], 25 (November 1989), 23-49.

63. "Contract Costs and Financing Decisions," Journal of Business, 63 (January 1990), S71-91.

64. "Term Structure Forecasts of Interest Rates, Inflation, and Real Returns," Journal of Monetary Economics, 25 (January 1990), 59-76.

65. "Stock Returns, Expected Returns, and Real Activity," Journal of Finance , 45 (September 1990), 1089-1109.

66. "Time, Salary, and Incentive Payoffs in Labor Contracts," Journal of Labor Economics, 9 (January 1991), 25-44.

67. "Efficient Markets: II," Fiftieth Anniversary Inveited Paper, Journal of Finance , 46 (December 1991), 1575-1617.

68. "The Cross-Section of Expected Stock Returns," (with Kenneth R. French), Journal of Finance, 47 (June 1992), 427-465. Winner of the Smeith Breeden Prize for the best paper in the journal during 1992.

69. "Diversification Returns and Asset Contributions, "with David G. Booth), Financial Analysts Journal, (May/June 1992), 26-32.

70. "Transitory Variation in Investment and GNP," Journal of Monetary Economics, 30 (December 1992), 467-480.

71. "Differences in the Risks and Returns of NYSE and NASD Stocks," (with Kenneth R. French, David G. Booth, and Rex Sinquefield), Financial Analyst Journal, (Janurary/February 1993).

72. "Common Risk Factors in the Returns on Stocks and Bonds," (with Kenneth R. French), Journal of Financial Economics, 33 (February 1993), 3-56.

73. "Size and Book-to-Market Factors in Earnings and Returns," (with Kenneth R. French), Journal of Finance , 50 (March 1995), 131-156.

74. "Multifactor Explanations of Asset Pricing Anomalies," (with Kenneth R. French), Journal of Finance , 51 (March 1996), 55-84.

75."Discounting under Uncertainty," Journal of Business, 69(October 1996), 415-428.

76. "The CAPM Is Wanted, Dead or Alive," (with Kenneth R. French), Journal of Finance , 51 (December 1996), 1947-1958.

77. "Multifactor Portfolio efficiency and Multifactor Asset Pricing," Journal of Financial and Quantitative Analysis, 31 (December 1996), 441-465.

78. "Industry Cost of Equity," (with Kenneth R. French), Journal of Financial Economics, 43 (February 1997), 153-193.

79. "Determining the Number of Priced State Variables in the ICAPM," Journal of Financial and Quantitative Analysis, 33 (June 1998), 217-231.

80. "Taxes, Financing Decisions, and Firm Value," (with Kenneth R. French), Journal of Finance , 53 (June 1998), 819-843.

81. "Market Efficiency, Long-Term Returns, and Behavioural Finance," Journal of Financial Economics, 49 (September 1998), 283-306. Winner of the Fama-DFA Prize for the best asset pricing paper in the journal during 1998.

82. "Value versus Growth: The International Evidence," (with Kenneth R. French), Journal of Finance , 53 (December 1998), 1975-1999.

83."The Corporate Cost of Capital and the Return on Corporate Investment," (with Kenneth R. French), Journal of Finance , 54 (December 1999), 1939-1967.

84. "Characteristics, Covariances, and Average Returns: 1929-1997," (with James L. Davis and Kenneth R. French), Journal of Finance , 55 (February 2000), 389-406.

85. "Forecasting Profitability and Earnings," (with Kenneth R. French), Journal of Business, 72 (April 2000), 161-175.

86. "Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay," (with Kenneth R. French), Journal of Financial Economics, 60 (April 2001), 3-43. Jensen Prize (second place) for the best 2001 Paper in corporate finance and organizations.

87. "Testing Tradeoff and Pecking Order Predictions about Dividends and Debt," (with Kenneth R. French), Review of Financial Studies, 15 (Spring 2002), 1-33.

88. "The Equity Premium," (with Kenneth R. French), Journal of Finance , 57 (April 2002), 637-659.

89. "New List: Fundamentals and Survival Rates," (with Kenneth R. French), Journal of Financial Economics, 72 (August 2004), 229-269.

90. "The Capital Asset Pricing Model: Theory and Evidence," (with Kenneth R. French), Journal of Economic Perspective, 18 (Summer 2004), 25-46.

91. "Financing Decisions: Who Issues Stock?," (with Kenneth R. French), Journal of Financial Economics, 76 (June 2005), 549-582.

92. "The Behavior of Interest Rates," Review of Financial Studies, Forthcoming.

93. "The Value Premium and the CAPM," (with Kenneth R. French), Journal of Finance , forthcoming.

[edit] References

[edit] External links

• Eugene Fama's home page at the University of Chicago
• Biography on Dimensional Fund Advisors website
  
  

v • d • e Financial economics awards Career awards Nobel Memorial Prize in Economics · Fischer Black Prize · Morgan Stanley-American Finance Association Award Research awards Brattle Prize · Smith Breeden Prize · Jensen Prize · Fama-DFA Prize · Michael Brennan Award