Friday, November 03, 2006

Eugene Fama Speaks

It's the start of a new week at Unknown University. And what better way to get it started off right than with an interview of one of the "founding fathers" of modern finance, Eugene Fama . His dissertation (published whole in the Journal of Business in 1965) set the groundwork for the modern version of the theory of efficient markets, and he's played a big part in many of its subsequent developments.

Click here to read an interview of Fama by Nina Mehtais in Financial Engineeering News.

Fama does a great job of explaining the way the development of the CAPM affected the discussion of market efficiency:

Nobody realized before that if the market was working properly, you had to say something about what the market was doing in setting prices in terms of the relation between expected return and risk. Something like the Capital Asset Pricing Model was necessary before you could really test market efficiency. If you look back, you can see primitive statements about expected returns that were built into tests people were doing. But they didn’t realize they were making these statements.

FEN: What are you referring to?
EF: If you say autocorrelations must be close to zero, what you’re really saying is that expected returns are constant, so that’s a statement about equilibrium right there.

There's much, much more in the article. Read the whole thing -- it's short, and well worth it.

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