“Eugene Fama will probably win the Nobel Prize someday for his work on the efficiency of financial markets.” If I had a nickel for every time I’ve said that, my vast wealth would permit me to ignore his teachings. This week, the folks in Sweden decided that the time had come to make it so.
Fama is best known for his work showing that assets are correctly priced based on currently available information. Here is how Rex Sinquefield wrote about him in Forbes this week Readers of this blog know that I rely heavily on his scholarship and often refer to “those things economists know to be fundamentally true.” For example, my contention that properly functioning markets eliminate all bargains builds directly on the work being recognized by the Nobel committee.
In referring to Professor Fama as “the father of efficient market hypothesis” we are also acknowledging his role in driving many people crazy. There is something about this basic scientific understanding of how properly functioning markets work that leaves people dubious. Indeed, it drives some folks to angry outbursts. “How can it be,” they wonder aloud, “that working hard to research companies will not beat randomly throwing darts?” It is certainly not intuitive. Maybe that is why keen academic insight into this remarkable attribute of markets is worthy of a Nobel Prize.
Let’s remember that nothing in Fama’s work argues that we can know the future. Rather, future valuation will depend upon unexpected and unknowable events that have yet to occur. By their very definition, these are things we cannot discover through research or analysis. Thus, the current price, while not a certain predictor of future value, is the most appropriate current price in light of available information. The powerful truth behind the efficient market hypothesis is not that future pricing is certain but, rather, that we cannot know it now.
What makes this week’s Nobel announcement so special is the practical application of the science being honored. Rarely is it true that understanding the work of the prize winner is incredibly valuable to each of us. In showing that we cannot effectively “beat the market” over the long term, Eugene Fama has offered us the opportunity to save a fortune. For many of us, over a lifetime, the value of his teachings will be measured in millions of dollars. Thank you, Professor Fama!