Press Releases Eugene Fama discusses his new five-factor model
Plus more from the Nobel Laureate on the Trump tax plan, the Euro, and his approach to research.
- By May 26, 2017
Eugene F. Fama, Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business arrived at the school in 1960, began teaching in 1963, won the Nobel Prize in 2013, and published more than 100 papers. In that time, Fama changed the way finance is viewed in theory and in practice—and he’s not done yet.
Fama and coauthor Dartmouth’s Kenneth R. French have returned to a groundbreaking idea they first proposed in 1993: a model to capture the size, value, and market risk of an asset for the purpose of pricing it. Known as the Fama-French Three Factor Model, it became the industry standard. Now, Fama and French have added two more factors—investment and profitability—to make the “Five-Factor Model.” In a forthcoming paper, “Choosing Factors,” they test its robustness.
“The three-factor model had a good run,” Fama told an audience at Chicago Booth’s 65th annual Management Conference earlier this month. “Like any model, it started to accumulate anomalies, and that’s what inspired the Five-Factor Model.”
In an hour-long session with alumni and students, Fama discussed taxes, banks, currency, and his philosophy of research. The following is an edited selection from the conversation.
What do you think about the Trump administration’s plans for the tax code?
You have to step back and ask how many times you want to tax the same dollar. Right now, it’s a mess. Simplifying the tax code, making it transparent—that would be good.
What about a single currency in Europe?
It’s a good idea, as long as you have free movement of people. Europe is drowning in its entitlements. They can’t pay them, given their low birthrate. They’ll either have to renege, or allow mass migration.
If you were king, what would you do about shadow banks?
Let them fail. I know that’s not popular, and it won’t happen. But “too big to fail” is the biggest blemish on capitalism, and now it’s institutionalized.
Index funds are coming back into style. What happens to asset prices if more people move away from active investing?
If everyone does it, you’re going to have random asset prices. So you have to have some smart investors taking advantage of their smarts. The market will be more efficient if the bad people drop off and the good people stay. I think there’s still a lot of room for that.
Tell us about your approach to your research.
My philosophy of research has always been: don’t try to think about a big problem. Do something you can manage, and if it’s any good, it’ll keep expanding and get bigger and bigger. That’s the way I’ve done it. The Five-Factor Model is an example.
How is research different from business?
In business, most of the time you’re not doing anything. Ten minutes here, ten minutes there you talk to people and things happen. Research is the opposite. You need long, concentrated periods of time. You know that if you get interrupted, you lose whatever you’re doing and it takes a while to get back to it.
In 2010, Eugene Fama was invited by the Annual Review of Financial Economics to write a professional biography. Read the article, “My Life in Finance,” to learn more about his career in research and teaching.
Watch MIT Sloan’s Professor Andrew Lo interview Fama about his groundbreaking research in modern finance, how he almost became a high school sports coach, and what makes a perfect portfolio.