Fama Nobel prize lecture

The American Economic Review published the lecture of economic Nobel Prize winner Eugen Fama in its the most recent issue. If you want a full-throated defense of efficient markets, this is the place. There is no room for doubt and there is little discussion of alternative views. Fama shows himself to be up for any battle defending his work in finance.

After being much maligned over the last two decades, it is good to see someone who is willing to defend one of the pillars of finance. I have my doubts on efficiency applying at all times, but it is still a foundation of finance no different than the idea of rational expectations or competitive markets. The core of Fama's discussion is the key idea that efficiency is a joint hypothesis of the market efficiency and the market model being used. The failure of a bad model tells us nothing about market efficiency. 

Fama discusses the event study approach as one of the premier tests of market efficiency. There are hundreds of papers that show that market reaction to news is swift and complete. He shows that predictive regressions add little value through his work on inflation forecasts and that the information embedded in forward rates is mostly about term premiums and not future spot rates. Expected stock returns are time varying and thus hard to forecast. Bubbles from his point of view may be a  concept that is overused and not easy to identify. Fama has little room for behavioral finance as an adequate explanation for price dynamics. 

He is a strong believer in the CAPM as a useful model as does not place a lot of stock in the so-called problems with the approach. He is, however, willing to agree that his three factor model with Ken French is an improvement on describing average returns. He views this work not as an indictment of efficiency but just as a more detailed description of the market. 

It is hard to disagree with his spirited defense if you are not aware of the controversies swirling around in finance. This is a strong defense of market efficiency but not even-handed.