Friday, December 6, 2013

Unintentionally hilarious Nobel coverage

Shawn Tully at Fortune wrote a very thoughtful piece describing Gene Fama's research and views on efficient markets.

The version I saw on  CNN money magazine is unintentionally both hilarious, and ends up making a far deeper point than I think Shawn intended.  It is chock full of little links trying to draw you off to other articles on the magazine. These were undoubtedly not put in or even reviewed by Shawn, but they tell you an enormous amount about the world of finance and finance journalism.

For example, here we are in the middle of an article describing Gene and efficient markets.
...Understanding Fama's evolving view of the market is one of the most valuable, practical guides for today's investors. 
MORE: 20 top picks from 20 star investors 
Fama's ideas may have received the ultimate validation, but they're still highly controversial.... 
Well, they haven't received the ultimate validation from the bots that run CNN money, that's for sure!

..."The efficient-market hypothesis is the North Star for everything in finance," says Asness. "One of the implications of his research is that every manager must be measured against a passive index to show if they're really successful, and almost all fail over time." 
MORE: A decade of markets, mayhem, and investing 
In that sense, Fama is the intellectual father of today's index fund industry. 
Only a decade? The comments just write themselves. 
...The overall market is a fabulous discounting machine, Fama contended, that handicaps future performance far more accurately than do active investors. The concept was shocking. It maintained that, contrary to virtually every other human endeavor, amateurs could easily beat professionals who pick individual stocks -- in this case by merely following a passive index.
MORE: Where Bill Gross is putting his money 
Fama's views quickly won acceptance among academics -- and scorn from money managers. [my emphasis] "They brushed us off, and they still do," says Fama. "I'd talk to reporters and they'd get it all backward."...
Hmm. Something tells me Bill Gross isn't putting his money in the Vanguard total market index, or even DFA core equity.  Are the links put in by a human with a devilish sense of humor? How can a computer program put in random links that are so hilarious, and so exactly opposite to the context? How can "more" link to things more exactly not "more?" A few more "mores" :
I saved the best for last:
...AQR Capital now incorporates momentum into the strategies behind many of its funds.
MORE: The Wall Street Stupidity Index
Perhaps the biggest challenge to the efficient-market hypothesis, however, came out of Fama's own research....
Just sit back and enjoy that one.

Shawn's final paragraph asks a deep question, made even deeper by the silly links that his publisher put in the article.
Is it possible, I ask him, that emotion and irrationality -- the hallmarks of the behavioral school of finance -- are far more powerful in explaining why folks are irrationally attracted to stock-picking managers than in explaining why stocks actually move? Fama shakes his head, chuckling. "I don't know the reason why active management is so dominant," he says. "At this stage, I find it completely puzzling." And inefficient.
Gene once said something to the effect that belief in inefficiency is mostly marketing for active management fees. But there is a deep point here.  Rationalists like us shouldn't just deplore something so persistent as folly (unless, I guess, perpetrated by the government). Active management must be serving some purpose to be so persistent in the marketplace... and in the ad machine on CNN's website.

(Epliogue: Jonathan Berk and Rick Green's papers start down a "rational " path of understanding active managment, but that's another story.) 


  1. Doesn't the Cognitive Dissonance Prize in Economics go to the Nobel committee for awarding a prize to an economist who says markets are efficient and one who says no they aren't?

  2. Great example of dramatic irony - perhaps rare in economics.

  3. Please explain your comment so that I cannot misinterpret it.

  4. There is a big difference between people who put their money in an actively managed fund and people who actively pick stocks, I think.

    I can imagine that the fund investors are mis-educated or are buying based on past performance the funds which survived (and thus there is bias _in past performance_ because only the better performers survived but _not in future performance_). They may be buying peace of mind to a point.

    People who personally pick stocks may either not want to diversify across the entire index (or incur even minor management fees) or may have a general instinct/ethical qualms that prevent the entire index from being appropriate. Alternatively, they may enjoy minor day to day gambling.

  5. I think it's a real mystery how info gets into prices given most active bets are inefficient, yet most investors do exactly that. Stiglitz and Rothschild's 'Impossibility' article would work, except one can't identify who, exactly, is informed, in practice.

    I think this is related to Keynes's statement that sufficient investment is dependent upon excessive optimism (delusion): "if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;"

    Delusional active investors are necessary to put info into prices, and so have a purpose. Not that it's individually rational. I think this is related to the note that when cities were becoming the key to the renaissance and rural people migrated there, creating the industrial revolution...the mortality rate was such that it was not in one's individual interest to move there, yet move there they did, to our ultimate benefit.

  6. Re: why actively managed funds persist despite the supposed outperformance of passive indexing. Obviously, there is some hidden systematic risk factor associated with passive investing.... ;)

    1. That hidden systemic risk factor is called goods going out of fad or becoming obsolete. Index funds follow the trend. Active investment can set the trend.

      Index fund investing allocates funds to individual companies either by market cap weighting or share price weighting. In either case, the financing needs of the individual companies within that index may not be optimally met.

      From an individual investor's standpoint it may make sense to buy into an index fund. From an individual company's standpoint it may not make sense to rely on index fund investors for external financing.

  7. Isn't it ironic that Chicago is one of the main centers of high frequency trading, which is all about predicting markets in the short term ? something that should be impossible according to efficient markets hypothesis?

  8. I have puzzled over this same phenomenon ever since I came across the EMH and Fama's work nearly 30 years ago. I am an agricultural economist and find the exact same behavior among farmers when it comes to marketing their crops. I spent over a decade showing that the "marketing gurus" that farmers pay good money for advice are actually a bit worse than just selling an equal amount over time ( The results were widely reported and discussed by farmers and appear to have had exactly zero influence on their marketing behavior.

    The best effort at reconciling this deep riddle I have found is in John Allen Paulos' book on a mathematician investing in the stock market: If you buy his arguments, then we should be happy that most people do not believe in market efficiency, as this belief is exactly what powers the effort to uncover pricing inefficiencies that makes the markets efficient!

    Scott Irwin
    University of Illinois

  9. I have a friend that used to work in Los Angeles as a bond salesman. His colleagues were stockbrokers to rich people there. One stockbroker tried to convince his clients to get out of their hedge funds and into California municipal bonds: he showed them that they would make more money in the long run, after taxes, in tax-exempt bonds. None of them were interested.

  10. Fama also says there are no bubbles, so I guess that means the Fed cannot cause bubbles either.

    Right now there is a Great QE Bubble-Hunt underway, although I think it will end up like the Great QE Inflation-Hunt, which ended up like the Great Snipe Hunt.

    I do wonder if gold is an exception and can have "bubbles." After all, what is gold worth? Largely used in jewelry in China and India, the value of gold is completely subjective, and the prospects for future prices can be anything you say.

    So we had gold reach towards $1000 in the 1980s, then sag for decades, then rise to nearly $2k back in 2011 and now sinking towards $1200. Adjusted of inflation, still well done from 1980s highs.

    I suppose Fama would argue that investors have relevant information for making gold worth $X, but I wonder. This may be the one market where there are really are "bubbles."

    People used to speak sonorously about the relationship of gold to silver, but that relationship has been haywire for decades.

  11. Article itself was very good - very accurate too. Liked to read about the personal side of Fama. On a side note it was a very high-level review of about 50% Advanced Investments course taught by John at Booth!

  12. The Guardian features some of the prize-winners comments about each other (mostly Shiller on Fama).

  13. Fama, bubbles and the EMH: as Fama once said, stocks go up and down all the time and some drawdowns can be severe. Markets always make mistakes but eventually correct. The term “bubble” does not contradict the EMH. You will probably have no trouble finding someone who correctly predicted the event. There are always some people to warn of stock market bubbles and crashes! The problem is finding someone who consistently predicts when these events occur (the key word here is "consistently"). If you keep predicting a market decline (or rise) you are bound to be correct at some time but this is probably not the best way to make money in the markets. Also, there are plenty of alleged bubbles in the world that have never resulted in a crash. You can never be sure that there is a bubble before it bursts and an alleged bubble does not always burst!

    1. this logic really is bizarre. For example, could Mark Zuckerberg consistently start new facebooks every 5 years ? just because he probably can't, that doesn't mean that when he started it, it was purely by chance. Same thing with bubbles - somebody who identified a particular bubble ahead of time, doesn't necessarily need to always identify all future future bubbles for the original discovery to be valid

    2. I meant that "someone who has identified a particular bubble in advance" may have just been lucky. There are plenty of people like Mark Zuckerberg in the world who will never reach his level of wealth, and this is not because they are less skilled than him. This depends on several factors, and yes, luck plays a role. In fact, in any activity in wich large numbers of people are engaged, chance will and does explain some extraordinary performances. It's only surprising to those who do not know the laws of chance.

    3. And Mark Zuckerberg is an entrepreneur whose business and success have nothing to do with the ability to predict stock prices.

    4. Lucky or not lucky: would Mark Zuckerberg have become what he is now, if he had never met the Winklevoss brothers?

    5. A broken clock is right twice a day! If bubbles are predictable or if indeed there is such a thing as a bubble then they should be predicted consistently and reliably. I don't get your truly bizarre reference to Facebook....Is Facebook a bubble BTW? What about Google? How about Apple? Amazon? now what about Bitcoin? get my drift.....


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