Eugene Fama
Economist and Nobel laureate
Born 1939
Developed the efficient market hypothesis and, with Kenneth French, the factor models that reshaped how returns are explained.
Biography
Eugene Fama, born in Boston in 1939, is an American economist and the Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. He studied Romance languages at Tufts University before moving to Chicago for an MBA and a doctorate, completing the latter in 1964, and has taught there ever since.
His doctoral work examined how share prices actually behave over time and found them far closer to unpredictable than the chart-reading of the period assumed. In 1970 he published the review that gave market efficiency its standard shape, separating the claim into three forms according to how much information prices are said to reflect: past prices alone, all public information, or all information including the private kind. The framing has organised the argument ever since.
The claim is narrower than it is usually reported to be. It does not say prices are correct, or that markets are wise, or that crashes cannot happen. It says that what is already publicly known is already in the price, which is why acting on a public document is unlikely to be an edge. He also identified the reason the hypothesis is so hard to test cleanly: any test of efficiency is simultaneously a test of whatever model you used to decide what a correct price would be, so a rejection can always be blamed on the model instead.
With Kenneth French he later produced the factor models that reorganised how returns are described, adding company size and relative valuation to market risk in 1993 and extending the set to five factors in 2015. He shared the 2013 Nobel Memorial Prize in Economic Sciences with Lars Peter Hansen and Robert Shiller, and has served as a director of Dimensional Fund Advisors, a firm built on applying this research, since the early 1980s.
Career timeline
- 1939Born in Boston, Massachusetts.
- 1960Graduates from Tufts University.
- 1964Completes a doctorate at the University of Chicago and joins its faculty.
- 1965Publishes his thesis work on the behaviour of share prices.
- 1970Publishes the review setting out the weak, semi-strong and strong forms of market efficiency.
- 1973With James MacBeth, publishes the regression method still used to test asset pricing models.
- 1993With Kenneth French, publishes the three-factor model adding size and relative valuation.
- 2013Shares the Nobel Memorial Prize in Economic Sciences with Lars Peter Hansen and Robert Shiller.
- 2015With Kenneth French, extends the framework to five factors.
Research approach
His method is to state a claim precisely enough that data can contradict it, then take it to the longest record available. That is why his conclusions are framed as hypotheses with named forms rather than as descriptions of how markets feel, and it is why the arguments against him have had to be arguments about evidence. A proposition that cannot be tested is not, in his practice, a finding at all.
What efficiency actually asserts is modest and frequently overstated by both its supporters and its critics. Prices reflect available information; they are not therefore right. A price can be wrong and still be the best available summary of what is known, which is a very different claim from the one usually attributed to him, and most of the popular objections are aimed at the stronger version he did not make.
The joint hypothesis problem is his own limit on his own theory, and he stated it rather than waiting for someone else to. Any test of whether prices are efficient requires a model of what returns investors should expect, so evidence against efficiency is equally evidence against that model. He treats this as an honest constraint on what the data can settle; critics treat it as the reason the theory is so hard to disprove.
Key ideas
Tap any idea to expand a plain-English explanation, why it matters, and where to learn more.
Prices already contain what is known
The core of the efficient market hypothesis: publicly available information is reflected in prices before an ordinary investor can act on it.
It sets a realistic expectation. Reading the same news everyone else has read is unlikely to produce an advantage, however carefully you read it.
A company reports strong results and the shares have already moved by the time most people see the headline, because the report was public the moment it was released.
Three forms of efficiency
The separation of the claim into weak form, covering past prices; semi-strong form, covering all public information; and strong form, covering private information too.
Different forms have very different evidence behind them, and lumping them together produces arguments where the two sides are discussing different propositions.
The evidence that past prices alone do not predict future ones is much stronger than the evidence that nobody ever profits from private information.
The joint hypothesis problem
The observation that testing market efficiency always means testing a model of expected returns at the same time, so the two cannot be separated.
It explains why decades of evidence have not settled the question, and why an apparent anomaly can be either a genuine inefficiency or a flaw in the model.
Finding that cheap shares outperform could mean the market misprices them, or that they are riskier in a way the model fails to capture.
Size and value as factors
The finding, with Kenneth French, that company size and the ratio of book value to market price help explain long-run differences in average returns.
It reframed performance analysis. A manager beating the market with small, cheap companies may be collecting a known characteristic rather than adding skill.
Two funds with the same return can look very different once you separate how much came from tilting toward smaller or cheaper companies.
Why this points toward index funds
The practical conclusion others drew from the research: if public information is already priced, paying for someone to act on it is a cost without a reliable benefit.
It turns an academic finding into a decision an ordinary saver can make, and it puts the focus on the one variable they fully control, which is cost.
A broad fund tracking a market charges a fraction of an actively managed one and does not need any information advantage to do its job.
Major contributions
- Gave market efficiency a testable definition with three distinct forms, which organised half a century of subsequent research.
- Identified the joint hypothesis problem, an honest limit on what any test of market efficiency can establish.
- Developed, with James MacBeth, a regression technique that remains standard for testing asset pricing models.
- Produced with Kenneth French the factor models that reframed how both academics and practitioners describe where returns come from.
- Supplied the intellectual foundation that the low-cost indexing industry was later built on, even though the practical case was made by others.
Major successes
- Shared the Nobel Memorial Prize in Economic Sciences in 2013 for empirical analysis of asset prices.
- Published the 1970 review that gave market efficiency its standard three-part definition and framed the debate that followed.
- Built, with Kenneth French, the factor models that are now the common language for describing sources of return.
- Has taught at the University of Chicago since the 1960s and holds a distinguished service professorship there.
- Has served as a director of Dimensional Fund Advisors since the early 1980s, a firm founded to apply this research in practice.
Important books
- The Theory of Finance1972
A graduate text written with Merton Miller. Technical rather than general reading, and included because it is where much of the early framework was set out formally.
- Foundations of Finance1976
His textbook on portfolio decisions and securities prices. Also technical; his ideas reached general readers mainly through other writers rather than through his own books.
Influence on investors
Almost every argument for low-cost index investing traces back through his research, even when the person making it has never read a word of it. Jack Bogle built a business on the practical implication, financial advisers repeat it daily, and the default assumption that an ordinary saver should not expect to beat the market is his finding restated in plain language.
The factor models changed how performance is judged. Before them, a manager who did well was assumed to have skill; after them, the first question is how much of the result is explained by a tilt toward smaller or cheaper companies. That single shift removed a great deal of unearned credit from the industry, and it is the reason modern fund analysis reports exposures rather than only returns.
Criticisms and debates
A balanced view includes the main criticisms and open debates, presented neutrally.
- Momentum is the anomaly that has not gone away. Shares that have risen recently tend to keep rising for a while, which the three-factor model does not explain, and Fama and French themselves described it as the premier anomaly in the literature.
- Behavioural researchers, Robert Shiller among them, argue that prices move far more than fundamentals can justify, which is hard to reconcile with prices that faithfully reflect information.
- Critics say the joint hypothesis problem leaves the theory close to unfalsifiable in practice, because any evidence against efficiency can be attributed to the wrong model of expected returns instead.
- The size and value premia have been noticeably weaker since the papers documenting them were published, which raises the question of whether they were compensation for risk, an artefact of the data, or an opportunity that closed once it was known.
- After the 2008 crisis he was widely criticised for questioning whether the word bubble carries a usable meaning, a position many economists found hard to accept given what had just happened in housing.
Lessons for investors
Plain-English takeaways. Context for learning, not advice to buy or sell anything.
- 1If information is public, it is probably already in the price, so an advantage has to come from somewhere else.
- 2A model that explains most of what returns do still leaves anomalies, and momentum is the one that has stayed stubborn.
- 3Size and valuation characteristics explain part of the long-run difference in returns, which is a description of the past rather than a promise.
- 4The case for a low-cost index fund does not require markets to be perfect, only for beating them consistently to be hard.
Notable quotes
“I take the market efficiency hypothesis to be the simple statement that security prices fully reflect all available information.”
Context: Fama's statement of the efficient-market hypothesis, the idea behind the case for index funds.
Frequently asked questions
Who is Eugene Fama?
Eugene Fama is an American economist born in 1939 and a professor at the University of Chicago Booth School of Business. He is known for the efficient market hypothesis and, with Kenneth French, for the factor models used to explain returns.
What is the efficient market hypothesis?
It is the proposition that prices reflect the information available about an asset. The practical implication is that acting on publicly known information is unlikely to give an investor a durable advantage.
What are the three forms of market efficiency?
Weak form says past prices contain no useful information about future ones. Semi-strong form says all public information is already reflected in prices. Strong form says even private information is, which is the version with the least support.
Does market efficiency mean prices are correct?
No, and this is the most common misreading. It says prices reflect what is known, not that what is known is complete or that the resulting price is right. A price can be a poor estimate of value and still be the best available summary of current information.
What is the Fama and French three-factor model?
It explains average returns using three characteristics: exposure to the overall market, company size, and the ratio of book value to market price. A later version adds profitability and investment to make five factors.
What is the joint hypothesis problem?
Any test of market efficiency also tests the model used to define what a correct price would be. Because the two cannot be separated, a result that looks like a market failure may instead be a failure of the pricing model.
Why do index funds follow from this research?
If public information is already in the price, paying someone to research it is a reliable cost in pursuit of an unreliable benefit. A broad low-cost fund captures the market return without needing an information advantage.
Related quotes
Other people in the library writing on the same themes.
“A low-cost index fund is the most sensible equity investment for the great majority of investors.”
Warren Buffett“Do not look for the needle in the haystack. Just buy the haystack.”
Jack Bogle“A blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts.”
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