My Sunday Washington Post Business Section column is out. This morning, I look at how Eugene Fama’s early insights were nearly eclipsed by his latter bad theories.

Not to give away the ending, but if it weren’t for Robert Shiller’s criticism, Fama may very well not have won.

Here’s an excerpt from the column:

“For this, Fama is thought of as the intellectual father of indexing. The entire concept of passive investing in indexes grew around his insights. His work became hugely influential, and remains so to this day. If you own a Standard & Poor’s 500-stock index, you do so because of Fama the Younger’s observations.

Had he stopped there, Fama the Younger probably would have flown to Sweden to pick up his Nobel Prize money decades ago.

But the years went by, and Fama kept coming back to his hypothesis. He pushed it to all manner of odd places. So the Nobel committee was confronted with the problem of Fama the Elder — the second Eugene Fama. That professor built on his own work. The influence of his insight imbued the Elder with prestige far beyond what his latter flawed work should have generated. It allowed him to expand his efficient-market thesis. That, dear readers, is where our boy ran into trouble.”

I usually can gauge how resonant a column is by the comment response — but not this time. As of Sunday at 8am, not a single reader responded to it! I assume its due to the wonky nature of the subject matter.

Regardless, I am really pleased with the clever way the inherent conflict of the Nobel committee gets resolved. You can read the entire piece here.


How Shiller helped Fama win the Nobel
Barry Ritholtz
Washington Post, October 20 2013

Category: Apprenticed Investor, Psychology, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

13 Responses to “Fama Has Shiller to Thank for his Nobel Prize”

  1. capitalistic says:

    It isn’t wonky. Most people don’t understand applied economics.

  2. RW says:

    A bit wonky, sure, but also a bold assertion that I think is pretty damned close to the mark. The addition of Hansen to Fama and Shiller by the Nobel committee masks this even as it bridges the gap because Hansen’s analytic techniques are widely used by both schools of thought.

    As Andrew Lo, a professor finance at MIT’s Sloan School of Management, phrased it: “The choice of having Hansen complement the two extremes of efficient markets and inefficient markets is the perfect balance between the two.” (Bloomberg)

  3. zell says:

    Wow! No comments? Too wonky? Maybe all your readers are traders. Very simple basic concepts.
    Shiller’s critique is operative now. The Fed is working hard to maintain a huge bubble. Bubble defined by mass behavior- which is not always wrong- but is a requisite for bubble formation. Of course the Fed is defined as the bubble master- don’t fight the Fed.But when the Fed herds actors to one side of the boat for too long the balance in the system is seriously disturbed to the short term benefit of many but with the longer term risk to the viability of the game itself.
    What pricks the bubble? The event/s.that causes actors to shift to the other side of the boat. When enough do slowly perhaps at first but then in mass capsize takes place.
    But not to worry because the Fed will repair the damage?

  4. flocktard says:

    Thank you for this piece, because it clarified one of the most bewildering pieces of news I’ve seen in a while. Someone called it the Nobel Committee’s “barbell strategy.”

  5. formerlawyer says:

    The lack of comments may be related to the internet outage in the northeast:

    As of now, there are 5 adulatory comments – good piece btw.

  6. sellstop says:

    I think it was on this site that I came across the recommendation for the book, “The Myth of the Rational Market”, by J. Fox. And that was where I came across Fama’s name and a brief history of his work. I have no extensive knowledge of what Messrs. Fama or Schiller have done. But the one thing that I am continually struck by regarding markets, market prognosticators, investment advisors and marketers of investment advice and expertise is that markets are made up of all the people in them. And any entity who discusses or mass markets information about “the market” must make the information as general as the particular market is broad. The analogy is to the insurance business and the science of the law of large numbers. A scientist can predict with statistical accuracy how many men in a large population will have a heart attack in one years time, but can not predict WHICH men will have a heart attack.
    It is the same with markets. One can use statistics to predict the average returns of market participants by their method of investing, but cannot predict the individual return of any. And this comes down to the principle that if everybody is doing something in a market it ceases to be profitable due to the inherent competition among participants.
    I am amazed at the large sums of money and effort that goes into quantifying these simple precepts and to making them acceptable to large groups of investors.
    I am reminded of a story in “Market Wizards” where the interviewer asks a pair of large and successful traders if they believe that trading on the fundamentals is dead, and they glance at each other and remark that they certainly hope not. (as I recall the passage)
    With mass movement of the public into investing in stocks as a method of saving for retirement it is not surprising that an efficient market theory must gain traction.

  7. NMR says:

    Actually BR I tried to comment but the site was forever “loading” which I assumed meant you were overwhelmed with comment. I’m not sure if your theory about the Nobel committee motivations is correct but a brilliant summation of the limitations of Fama-ism and the role of Rob Schiller in blowing him out of the water.

  8. rd says:

    The real “Father of Indexing” thinks Fama’s EMH is sometimes right and sometimes wrong. Bogle prefers to think of it as the CMH instead of EMH – “Cost Matters Hypothesis”.

    Bogle has generally attributed the concepts behind his S&P 500 index fund to Paul Samuelson, not Eugene Fama. I have seen interviews with him where says he didn’t know about Fama’s research until 10 years after the Vaguard S&P 500 index fund was started.

    It is also a huge irony that DFA, the indexing company that Fama is affiliated with, specializes in slice-and-dice indexes so that investors can bet on market sector inefficiencies that theoretically don’t exist according to Fama – the most famous one is the small value premium. It took a long time for Vanguard to move to the same slice-and-dice concepts since Bogle was a major believer in simply buying big, really diversifiedvery low cost indexes.

    Fama and others, including Greenspan, Rubin, Summers, etc. have done huge damage with the EMH-based push for deregulation. Nobody in the US has ever seriously proposed eliminating all of the laws prohibiting murder, assault etc. and eliminating the police because people are naturally “self-regulating” since it would be in their rational self-interests not to kill and maim people because people may do the same to you. For some reason though, people believe that de-regulating the financial sector because the market will efficiently price everything due to perfect information. In reality, there is always a group of psychopaths who will take advantage of a lawless system, societal or financial, to further their own self-interests regardless of the impact on society.

  9. d_dd says:


    Fama’s Efficient Market Theory work represents just a fraction of his important contributions to financial research. The Fama-MacBeth method is one of the most fundamental tools for studying risk-return relations. The FFJR event study methodology is a seminal tool for understanding the impact of information and announcements on the prices of financial securities, whether markets are efficient or not. In addition, there is his important research on interest rates and inflation. Also, the influential Fama–French three-factor model has integrated much of the important empirical research in the field on expected return relations. For all these reasons, few academics would deny that Fama is truly the father of empirical finance – a giant among researchers.

  10. Matt P. says:

    What d_dd said above is correct. The article glosses over almost everything. In fact the best critic against EMH was Fama himself when he forwarded the Three-factor (now probably 5) model. Here is a much more detailed, accurate and wonky overview of his contributions for those that are interested.

  11. zell says:

    Empirical finance? What is that? Models? What does the financial community/ business folk know now that they didn’t prior modeling? To me it all looks like the same old game. Remember when the modelers were predicting a budget surplus for as far as the eye could see? All they were looking at was a manifestation of tech innovation and it’s extrapolation into the tech bubble.

  12. DeDude says:

    As a theoretical construct the efficient market hypothesis assume that 100% of the participants have 100% knowledge and are 100% able to act rationally on that knowledge. In practice, that is newer the case. However, in rare cases some markets are close enough that you can use EMH in models and end up with something useful. Problem is that people have tended to ignore all the caveats of EMH either because it is so much harder to model inefficient markets, or because it feed their ideological addiction to small government. Some of that ideological addiction has (surprise?) lead to absurd inconsistencies such as believing that people will act in self interest (maximizing profits) to make markets efficient, yet they will not rig markets and withhold information to further maximizing their personal profits (making markets less efficient). So it had little to do with actually believing in the theoretical framework of EMH and more to do with using it as an argument in favor of less government.