‘Fields Are Not Revolutionized That Often’

Harry D’Angelo: The University of Chicago in the 1960s was ground zero for a data-driven, scientific revolution that radically transformed the academic world of financial economics and real-world investment practices. In this roundtable discussion, Eugene Fama, Richard Roll, and Myron Scholes share memories of their time together in the 1960s in the finance group at what is now known as the Booth School of Business of the University of Chicago.

Eugene Fama: Merton was a great influence on my life and everybody else’s life. I can remember as a PhD student, I had one kid and another kid on the way, so I was anxious to get out of there quickly, so when it came time to write a thesis, I would show up almost every day waiting for him to come into the office and go in and show him what I had done the night before at the computation center. And he was always very patient with me and answered all the questions and everything. And I remember that afterwards, whenever I would get nervous with a kid about this thesis, I thought, “Well, what did Miller do for me? And maybe I should try to imitate that a little bit.”

Richard Roll: I would say this, that going back to the 60s, one thing that really struck me as, after the fact, being important is that all the PhD students were housed in the basement of Haskell Hall. We were down in the basement, and we had all these offices in the basement. Mike and I shared an office, so he and I got to know each other pretty well. He’d always rib me because I had a schedule where I would study French for one hour and then econometrics for another hour and so on. But he taught me, I’ll never forget, one day we were talking about regressions, and he said, “What is this disturbance term? If you have A + BX + ε, what is epsilon?” I said, “Well, it’s a random variable, right?” He said, “No, not a random variable.” I said, “Well, what is it?” He says, “Well, if the left-hand side is a return, and the explanatory variable is the market, that’s an extra return that you get because of economic facts that happen to the company, right?”

That’s the first time I thought about it. I always thought, I’m an engineer, so I thought when you run a regression these things are all just random, but they’re not, right? And he’s the first person that I remember telling me that that was actually something other than just a random event. That turns out to be really important and something you’re going to bring up later. The event studies, which you’re going to talk about, because that’s the key basically, to think about that residual as being something other than just a purely random number. And to me, I don’t remember anybody else, maybe somebody told me that before, but I don’t remember it, but I remember arguing with him about it. I said, “No, no, that’s random. It’s normally distributed. Zero mean and a standard deviation.” He said, “No, that’s not right.” But he was messianic, so he could carry the day. If he was sure of something, he’d ultimately convince you of it.

Myron Scholes: It’s funny, we have other stories about Mert, but when I went to Mert, I was giving talks to an audience. I say, “Mert, you always have a nice story you tell people when you start your talk.” I said, “Can you give me a story to tell so I can warm the audience up and I can get with them and have some degree of association?” So, he gave me, “Tell this joke Myron.” So, I listened to the joke. I didn’t really understand the joke, really what he was saying, but I told it to the first conference, I gave the story, no one laughed. The second conference I gave, I told the same, no one laughed. So, I went to Mert and said, “Mert, there’s something wrong with this joke. Basically, no one was laughing at it.” He said, “I didn’t get the joke either.” That’s why he gave it to me.

D’Angelo: But I guess what I’m trying to get at or trying to understand, or would like to understand, is to what degree was there dissent within Chicago about the new ideas? Was there resistance? Were there fights or trying to, let’s try to figure out what they mean.

Fama: Mert never gave up the idea that the money supply produced stock prices. Never gave up on that.

D’Angelo: Who did?

Fama: Milton Friedman.

D’Angelo: Milton Friedman. Okay.

Fama: And he didn’t have any respect for finance.

D’Angelo: No.

Fama: When they gave a Nobel Prize to three people in finance, he basically said, “There’s nothing in finance that deserves a Nobel Prize.”

D’Angelo: Right.

Fama: My response was, “That’s strange comment from a macroeconomist.”

D’Angelo: Right? No, I agree. Did Friedman resist your dissertation?

Fama: He wasn’t involved with it.

D’Angelo: No.

Fama: He had nothing to do with it.

D’Angelo: Well, obviously, he was a big presence at Chicago. Did you have a sense–

Roll: He was in another department. He was not in business.

D’Angelo: Different, different?

Roll: Yeah, he was–

Scholes: In the economics department.

D’Angelo: So he was a non-entity or you?

Roll: No, no. A lot of us went to, I took his class.

Scholes: I took it.

Fama: I did too.

Scholes: I did too.

Fama: I got the highest grades in the exams, and everybody was always shocked that I would question him in class and challenge him. He said, “Nobody does that to Friedman.” Nobody took this class for credit. They were afraid to take it for credit, and I was challenging him. So, in the end, I got the highest grade on the exam. He gave me a B for the course.

D’Angelo: Are you serious?

Fama: Yeah. Dead serious.

D’Angelo: And because you were a renegade?

Fama: Well, because I challenged him.

D’Angelo: Yeah.

Fama: You didn’t do that. He ran the workshop. He ran the money workshop for years, and it took a while to figure out he had this way of doing it. So, he would go to page one. He’d go through the paper, page one, page two, and he’d comment on it and nobody else basically said anything. So, this was kind of the Milton show and yeah.

D’Angelo: This is fascinating.

Fama: And then Fisher Black and I started to go to the workshop and challenged him on these things. And he wrote a letter for Fisher when we were giving him tenure that said, “This guy’s crazy.” He said, “This guy doesn’t deserve it. Merton and I said, “Just throw that away. Just throw it away.”