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  • Nobel Prize Winner Eugene Fama Explains Why You Have No Chance Of Beating The Market

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  • Business Insider
    Eugene Fama
    Professor Eugene Fama of the University of Chicago was one of the three economists to be awarded the 2013 Sveriges Riksbank Prize in Economic Sciences.
    The theme of this year's award "Trendspotting in asset markets," and the Nobel committee pointed to Fama's ground-breaking work advancing the Efficient Market Hypothesis (EMH).
    "Beginning in the 1960s, Eugene Fama and several collaborators demonstrated that stock prices are extremely difficult to predict in the short run, and that new information is very quickly incorporated into prices," they explained. "These findings not only had a profound impact on subsequent research but also changed market practice. The emergence of so-called index funds in stock markets all over the world is a prominent example."
    The EMH more or less argues that the all available information is already priced into the market. And therefore, it is basically impossible to beat the market.
    Here's an excerpt from Wikipedia:

    Fama is most often thought of as the father of efficient market hypothesis, beginning with his Ph.D. thesis. In a ground-breaking article in the May, 1970 issue of the Journal of Finance, entitled "Efficient Capital Markets: A Review of Theory and Empirical Work," Fama proposed two crucial concepts that have defined the conversation on efficient markets ever since. First, Fama proposed three types of efficiency: (i) strong-form; (ii) semi-strong form; and (iii) weak efficiency. They are explained in the context of what information are factored in price. In weak form efficiency the information set is just historical prices, which can be predicted from historical price trend; thus, it is impossible to profit from it. Semi-strong form requires that all public information is reflected in prices already, such as companies' announcements or annual earnings figures. Finally, the strong-form concerns all information, including private information are incorporated in price; it states no monopolistic information can entail profits, in other words, insider trading cannot make a profit in the strong-form market efficiency world. Second, Fama demonstrated that the notion of market efficiency could not be rejected without an accompanying rejection of the model of market equilibrium (e.g. the price setting mechanism). This concept, known as the "joint hypothesis problem," has ever since vexed researchers. Market efficiency denotes how information is factored in price, Fama (1970) emphasizes that the hypothesis of market efficiency must be tested in the context of expected returns. The joint hypothesis problem states that when a model yields a return significantly different from the actual return, one can never be certain if there exists an imperfection in the model or if the market is inefficient. Researchers can only modify their models by adding different factors to eliminate any anomalies, in hopes of fully explaining the return within the model. The anomaly, also known as alpha in the modeling test, thus functions as a signal to the model maker whether it can perfectly predict returns by the factors in the model. However, as long as there exists an alpha, neither the conclusion of a flawed model nor market inefficiency can be drawn according to the Joint Hypothesis. Fama (1991) also stresses that market efficiency per se is not testable and can only be tested jointly with some model of equilibrium, i.e. an asset-pricing model.

    Page 2 of 2 - However, not everyone agrees with the stronger forms of the EMH. In particular, the hedge fund industry has long argued that it is possible to find small opportunities or have an informational edge, among other things, which help generated extraordinary returns.
    Regardless, everyone seems to agree that mom-and-pop have almost no hope in making money by trading in the short-term.
    And we can all thank Fama for advancing that.
    Here's the slide that the Nobel committee showed while presenting Fama with the award.
    eugene fama
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