Eugene Fama is known as a father of modern finance.
He was born in February 14, 1939 in
Boston, Massachusetts, son of Angelina and Francis Fama. Fama is Malden Catholic High school athletic honoree. Fama became a father of four and grandfather of 10. Fama did his under graduation in romance languages magna cum laude from Tufts University in 1960, here he was awarded as an outstanding athlete of the school. Fama did his MBA and Ph.D. from booth school of business at Chicago University in economics and finance. Fama got supervision from Nobel Prize winner Merton Miller and Harry Roberts in Ph.D. and also get influence from Benoit Mandelbrot. Fama get a major influence for his work from his supervisor Merton miller. Fama was awarded with a degree of Doctor of Law by DePaul University and university of Rochester. Furthermore, Fama was also awarded with the doctorate of Science causa by Tufts University and Doctorate of Honoris Causa by Catholic University of Leuven, Belgium. Fama Ph.D. thesis is on random walk hypothesis of stock movement, and was published in Journal of Business 1965 issue with the title of The behavior of Stock Market Prices. This thesis was rewritten and published as Random walks in stock market prices and was published in 1965 in financial analyst journal and institutional investor in 1968. Fama joined GSB (graduate school of business) faculty in 1963 and spent all of his teaching at university of Chicago. Along with Nobel Prize, Fama became first fellow of American finance association in 2001. Fama also became a member of econometric society and American academy of sciences and arts. Fama also became a first recipient of 3 major awards in field of finance. (Deutsche Bank Prize in Financial Economics (2005), the Morgan Stanley American Finance Association Award for Excellence in Finance (2007), and the Onassis Prize in finance (2009)). Other awards won by Fama includes Chaire Francqui (Belgian National Science Prize) in 1982, Nicholas Molodovsky Award 2006, Fred Arditti Innovation Award (2007). Fama Get Nobel prize in 2013 for his tremendous work in field of economics named a The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobels. Fama is famous for his theoretical and empirical research work. His academic focus is in financial economics, and his major contribution to the field of Economics includes Random Walk Hypothesis and Efficient market hypothesis. Fama became an author of 2 books and more than 100 articles. Today Fama became one of the most cited researcher in field of economics. Fama is one of those economists that has an influence in both Academia and outside it. Fama books include Foundations of finance and The Theory of Finance, which he wrote with Merton H. Miller, who became Nobel Prize winner in 1990. Fama is well known for his efficient market hypothesis, in which he describe the three dimensions of efficient market 1) weak form 2) semi-strong form 3) strong form of efficient markets. In weak form hypothesis, only the previous prices affect the market. On the other hand, semi strong market incorporates all the public information of the companies along with historical prices in the stock prices. Finally, the strong form of market incorporates all the public, private and previous trends information in the stock prices. Along with efficient market hypothesis, another major contribution of Fama is the three factor model of asset pricing. This model was designed by Eugene Fama and Kenneth French for the description of stock returns. This model says that the risk is not only measured through market risk beta, but there are other factors like small minus big capitalization companies and high book to market versus low book to market ratios also affect the risk of a security. Efficient Market Hypothesis: The main contribution of Eugene Fama to the field of economics is efficient market hypothesis, upon which he receive Nobel Prize. Fama proposed the concept of market efficiency and of the view that it is impossible to outperform the market, because of its information efficiency. Fama says that the main drawback of the previous studies is the lack of consensus on the definition of efficiency. Some people consider efficiency definition as defined in statistics with the name as efficient estimators and etc. Fama defines the term efficiency in the simple criteria named as information efficiency. This term means that if the stock prices incorporate all the information then markets are termed as efficient markets. This means in case of efficient markets, no time available for both technical analysts and fundamental analysts to select undervalued securities from the market, because market cannot give enough time to the outperform it. Fama on the basis of this theory defines that it is impossible to select efficient securities in the market. The selection is just like throwing darts into air and depends entirely upon luck. Fama further classifies the efficiency of markets into three stages named as: 1) strong efficiency 2) semi- strong efficiency 3) weak efficiency. All these stages define different level of markets to react to the information of future prices. Eugene efficient market hypothesis theory faced a lot of criticism from the people. People who opposed EMH are of the view that the prices of the securities are repeated and shows the trends, so technical analysis cannot be eliminated. Prices of the securities also depend upon the expectation of investors about the future prices, which is based upon the previous price trends. Weak form of efficiency defines the situation in which stock prices incorporates all the publically available information. Semi- strong efficiency defines the situation in which stock prices incorporates published information in addition to weak form of efficiency. Strong form efficiency is one in which market incorporates both weak and semi strong efficiencies along with the insider information into share prices, which results in impossibility to beat or outperform the market. Proponents of the theory defined by professor Fama says that the theory cannot consider behavioral aspects of the investors like cognitive biases due to which markets shows inefficiency. The main proponent of the theory was Paul Samuelson, who is of the view that stock markets are micro-efficient not macro-efficient. This means that markets are considered to be efficient with respect to the individual security, not with respect to whole market. Paul on the basis of this argument concluded that EMH is suitable for individual securities, not for whole markets. Theoretical Background of the theory: The main justification behind the work of Fama is the expectations of agents. Fama defines that beyond normal utility maximizing agents, markets require rational expectation agents, and so average results became normal. He further says that this rational expectation of agents does not mean that all the agents react to new information in a same manner. Some people overreact on the information, while some under reacts the situation. Hence, we can say that expectation of investors are random and follow a normal distribution pattern. On the basis of this argument, net results of market are normal average and does not show any change in exploitation of market towards abnormal profits with respect to transection and brokerage costs.