Interview with Eugene Fama

I was in Belgium for two years working solo. When I returned, I showed Merton Miller my research produced over that two year period, and he put aside most of it with the comment, “Garbage.” He was right on every count…

[Pensions] should be discounting the liabilities at the expected return implied by the risk of the liabilities, not the expected return on the assets. The liabilities are basically indexed claims—like a TIPS (Treasury Inflation-Protected Security). Therefore, the appropriate discount rate on the high side should be about 2.5%, not the 7% or 8% that the plans are using now…

In Daniel Kahneman’s book Thinking, Fast and Slow, he states that our brains have two sides: One is rational, and one is impulsive and irrational. What behavior can’t be explained by that model?…

Litterman: What’s your view of the purported excess return of low-volatility stocks? Fama: The excess return is really a result of low beta, not low volatility, and this potential source of return has been well known for 50 years. When the first tests of the CAPM were done, the problem always out front was that the market line, or the slope of the premium as a function of beta, was too low relative to what the model predicted. This meant that low-beta stocks had higher returns than predicted and high-beta stocks had lower returns than predicted….

I agree with Fama on almost everything, the exception being the risk premium. Fama seems to think the Security Market Line (SML) is increasing but too flat, rather than downward sloping. The return premium to low volatility equity portfolios is a profound fact and many experts can’t see, even though it’s there in the data, and the returns of traded low volatility funds. A ‘too flat’ SML is one thing, a negative one, quite another. One implies tweaks, the other, a paradigm shift. 

Comments

Click here to cancel reply.

Your Comments