Eugene Fama

Definition

Eugene Fama is an American economist widely recognized as the father of modern finance, particularly known for his work on efficient market hypothesis (EMH) and portfolio theory. His research fundamentally changed the way economists and investors view financial markets, suggesting that asset prices reflect all available information and that it's difficult to achieve higher returns without taking on additional risk. This perspective is crucial for understanding international portfolio investment as it influences how investors assess foreign assets and market behavior.

5 Must Know Facts For Your Next Test

1. Eugene Fama's groundbreaking paper on the efficient market hypothesis was published in 1965, fundamentally influencing investment strategies and academic finance.
2. Fama's research indicates that active investment strategies tend to underperform passive investment strategies over the long term, especially in efficient markets.
3. He received the Nobel Prize in Economic Sciences in 2013 for his empirical analysis of asset prices and contributions to the understanding of market efficiency.
4. Fama's work has led to a better understanding of how international portfolio investments should be diversified to mitigate risks while maximizing returns.
5. The concepts introduced by Fama have shaped modern financial practices, affecting everything from mutual fund management to individual investor strategies globally.

Review Questions

• How does Eugene Fama's efficient market hypothesis impact investor behavior in international portfolio investments?
  • Eugene Fama's efficient market hypothesis suggests that all available information is already reflected in asset prices. This leads investors to believe that attempting to outperform the market through active management is generally futile. As a result, many investors opt for passive strategies when investing internationally, focusing on diversified portfolios that align with market performance rather than trying to predict price movements.
• Evaluate the implications of Eugene Fama's research for risk assessment in international portfolio investments.
  • Eugene Fama's research emphasizes that higher expected returns come with higher risks. In the context of international portfolio investments, this means investors must carefully assess the political, economic, and currency risks associated with foreign markets. By understanding the efficient market hypothesis, investors are encouraged to analyze how these risks affect asset pricing and to structure their portfolios accordingly to balance risk and return.
• Critically analyze how Eugene Fama's theories have influenced current financial strategies employed by global investors.
  • Eugene Fama's theories have profoundly influenced modern financial strategies by promoting the idea that markets are efficient and that active management is often less effective than passive management. This has led global investors to adopt index funds and exchange-traded funds (ETFs) as preferred investment vehicles. Furthermore, Fama's work encourages diversification across international assets to reduce unsystematic risk while accepting systematic risk inherent in the markets, reshaping how portfolios are constructed today.

Related terms

Efficient Market Hypothesis: A theory proposing that asset prices fully reflect all available information, making it impossible to consistently achieve higher returns than the average market return.

Random Walk Theory: A financial theory stating that stock price changes are random and unpredictable, implying that past price movements cannot be used to predict future prices.

Capital Asset Pricing Model (CAPM): A model that describes the relationship between systematic risk and expected return, used to price risky securities in international markets.