Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by burritoLover »

JoMoney wrote: Sun May 15, 2022 9:21 am
mary1492 wrote: Sun May 15, 2022 9:03 am
JoMoney wrote: Sat May 14, 2022 3:21 pm If the EMH guy says I don't need International, then I'm getting some International... I consider Fama the Jim Cramer of investment academia ;) :P :twisted:
Agreed. EMH is flawed in a big way. It becomes more obvious over time.
Examples of the flaws in presuming the market is efficiently pricing risk or even for a particular return objective, or share the same time-line for that objective, have become more apparent to me of late. Things like the whole "meme stock" fiasco, I wonder how Fama rationalizes the efficiency of GameStop stock pricing? Or with this ESG movement among institutions that seem to have thrown out the idea of a business prioritizing the product they deliver to consumers and the profits to their investors. In the past there were studies done showing a premium for "sin stocks", I wonder if there will be yet another market "anomaly" for investing in businesses with boards that take their fiduciary responsibilities as having a financial priority first.

Don't get me wrong, I do think markets are competitive and that low-cost broad market indexing will beat most other strategies. The aggregate of the stock market isn't going to achieve anything extra by people trading it. But I don't think the EMH or "risk premiums" explain what is going on.
Here's what he said:
So is there an efficient markets explanation for what happened with GameStop?

I don't follow these individual little aberrations if you might say. But remember now, efficient markets is a model. We call it a model because it's not reality. It's an approximation. Models are approximations. It's an approximation that works quite well for almost everything you want to do in investing. But sometimes there are aberrations. So I didn't follow the meme stuff thing very closely, but apparently that was an aberration, it was a small stock that went crazy.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by mary1492 »

xyzzy
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Seasonal »

mary1492 wrote: Sun May 15, 2022 11:25 am Not surprising - always have an explanation ready to CYA.

It's an approximation that works quite well for almost everything ("you want to do in investing"), except when it doesn't. When it doesn't, it's called an "aberration" because it's certainly not the model that might be wrong, it's the situation. When markets get crushed and the folks at the top of the Wall Street firms are dragged in front of Congress to explain what happened, their go-to excuse is the "once in a thousand year event" (which recurs about once every 10 years). The "aberration" is Fama's once in a thousand year event.

He's obviously totally in the dark about GameStop and similar meme stocks = excuse #2 - "Well, I don't follow that...but it was an aberration too...because my model can't explain it".
Let's assume EMH is false. What difference would that make in practice?
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Corvidae »

Seasonal wrote: Sun May 15, 2022 11:36 am
Let's assume EMH is false. What difference would that make in practice?
It would be described as a modeling convenience, which seems more accurate. Some published papers would not have been published, and some unpublished papers would have been published. Debate about market efficiency could then focus more on the practical considerations you ask about, rather than the consequences restricted to a world under questionable modeling assumptions. At least... that probably is what would happen.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by vineviz »

mary1492 wrote: Sun May 15, 2022 11:25 am Not surprising - always have an explanation ready to CYA.
It's not CYA: it's intellectual honesty. Every bit of evidence we have about the way that markets work tells us the they are efficient.

Every.

Bit.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by secondopinion »

vineviz wrote: Sun May 15, 2022 1:44 pm
mary1492 wrote: Sun May 15, 2022 11:25 am Not surprising - always have an explanation ready to CYA.
It's not CYA: it's intellectual honesty. Every bit of evidence we have about the way that markets work tells us the they are efficient.

Every.

Bit.
Indeed. I am glad they are efficient, because that means that I merely have to identify profitable risks and I will make money on average (hence likely long-term profits).

Like with Gamestop, who expected that was coming? Some had a hunch, most did not. Those with the hunch dictated the price (and the short funds moderated it). It not was an "aberration" of the model; the pricing included that very unlikely long-shot spike (it increased a bit as that likelihood increased). It just happened to happen. Most of the time, these moves into such stocks fail. The very few stock survivors tend to pay the investors heavily. Why would an investor bother with such stocks if there was no chance of an massive profit (because certainly it was not going to be that likely that they would stay in business)? It is market efficiency. It does not mean that the return profiles are the same or even equally profitable on average. As a speculator, I count on the return profile being a certain way -- not that I have information superior to another -- to make the hoped for profits.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Corvidae »

In calling it an aberration, Fama is admitting it might not fit the model.

One thing is for certain: not all academics agree with Fama. Voices are amplified through their connections. Booth and Booth descendants obviously maintain a significant influence in academic publishing.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by billaster »

vineviz wrote: Sun May 15, 2022 1:44 pm Every bit of evidence we have about the way that markets work tells us the they are efficient.

Every.

Bit.
The evidence suggests that it's hard to beat the market by picking stocks. Taking the Efficient Market Hypothesis to mean more than that can be dangerous.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by vineviz »

Corvidae wrote: Sun May 15, 2022 2:24 pm One thing is for certain: not all academics agree with Fama. Voices are amplified through their connections. Booth and Booth descendants obviously maintain a significant influence in academic publishing.
It's not about "agreeing with Fama". Virtually every student of markets acknowledges that most markets, most of the time, are incredibly efficient at pricing in available information, preferences, and restrictions.

You certainly don't have to look hard to find economists who will tell you that markets are not completely efficient. Even Fama would tell you that if you asked him.

But precious few economists genuinely believe that markets aren't mostly, or even overwhelmingly efficient. And those precious few have - so far - not proposed an alternative model that holds up to scrutiny to the degree that EMH does.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Corvidae »

vineviz wrote: Sun May 15, 2022 2:58 pm
Corvidae wrote: Sun May 15, 2022 2:24 pm One thing is for certain: not all academics agree with Fama. Voices are amplified through their connections. Booth and Booth descendants obviously maintain a significant influence in academic publishing.
It's not about "agreeing with Fama". Virtually every student of markets acknowledges that most markets, most of the time, are incredibly efficient at pricing in available information, preferences, and restrictions.

You certainly don't have to look hard to find economists who will tell you that markets are not completely efficient. Even Fama would tell you that if you asked him.

But precious few economists genuinely believe that markets aren't mostly, or even overwhelmingly efficient. And those precious few have - so far - not proposed an alternative model that holds up to scrutiny to the degree that EMH does.
That all sounds reasonable and is a slightly more accommodating perspective than your previous comment.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by PicassoSparks »

In two posts, you went from “Every. Bit.” of evidence supports EMH to
vineviz wrote: Sun May 15, 2022 2:58 pm most markets, most of the time,
That’s an enormous difference!

Fame’s own work ends up requiring an (evolving) set of factors to explain why the empirical evidence of markets behave they way they do in apparent defiance of EMH.

There’s this wonderful debate between Fama and Thaler where, like GameStop, Thaler has some examples of pretty obviously non-efficient market results and Fama has to dismiss them as anecdotes, much as he does GameStop.

https://www.youtube.com/watch?v=bM9bYOBuKF4

I would think that, as an academic, once you start omitting inconvenient evidence, you are starting down a dangerous path. I wish Fama showed more interest in these exceptions. Especially since, despite being so weird, they can be pretty consequential.

I get that, for most of us, most of the time, it makes the most sense to treat markets as efficient. But I’d expect the people who make a living studying these things to hold themselves to higher standards.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by whodidntante »

Do you often quote Fama or just when he confirms your bias?
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by whodidntante »

PicassoSparks wrote: Sun May 15, 2022 3:34 pm In two posts, you went from “Every. Bit.” of evidence supports EMH to
vineviz wrote: Sun May 15, 2022 2:58 pm most markets, most of the time,
That’s an enormous difference!

Fame’s own work ends up requiring an (evolving) set of factors to explain why the empirical evidence of markets behave they way they do in apparent defiance of EMH.

There’s this wonderful debate between Fama and Thaler where, like GameStop, Thaler has some examples of pretty obviously non-efficient market results and Fama has to dismiss them as anecdotes, much as he does GameStop.

https://www.youtube.com/watch?v=bM9bYOBuKF4

I would think that, as an academic, once you start omitting inconvenient evidence, you are starting down a dangerous path. I wish Fama showed more interest in these exceptions. Especially since, despite being so weird, they can be pretty consequential.

I get that, for most of us, most of the time, it makes the most sense to treat markets as efficient. But I’d expect the people who make a living studying these things to hold themselves to higher standards.
I think he acknowledges anomalies and the limitations of the models he has developed. FF 5 factor isn't perfect, but it's better than CAPM and it's better than FF 3 factor. Dr. Fama isn't happy about the investment factor, for example. And momentum is just inconvenient.

Maybe there is confusion on the goal, though. The returns of individual securities need not be explained by a factor model, so good luck sorting that out.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by vineviz »

PicassoSparks wrote: Sun May 15, 2022 3:34 pm In two posts, you went from “Every. Bit.” of evidence supports EMH to
vineviz wrote: Sun May 15, 2022 2:58 pm most markets, most of the time,
That’s an enormous difference!
Difference from what? What I wrote above is exactly what the EMH says.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by vineviz »

PicassoSparks wrote: Sun May 15, 2022 3:34 pm I would think that, as an academic, once you start omitting inconvenient evidence, you are starting down a dangerous path. I wish Fama showed more interest in these exceptions. Especially since, despite being so weird, they can be pretty consequential.
I'm not sure I understand this criticism. Fama has spent virtually his entire academic career examining "exceptions", "aberrations", etc.

I suspect if Gamestop revealed anything about markets that Fama hadn't seen hundreds or thousands of time in his career that he wold have paid more attention to it.

It's kind of like expecting a state trooper to be shocked, after decades on the job, that people sometimes drive under the influence of alcohol.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by nisiprius »

folkher0 wrote: Sat May 14, 2022 5:11 pm...FWIW the “international” question occupied very little of the episode. Frankly it seemed more like a footnote...
I thought this was important. I won't call it a bombshell, but it certainly confirms my own skeptical ideas. My underlining.
Interviewer: What do you think makes sense to use as an estimate for expected stock returns, just market returns?

Fama: Okay. That's a very good question because I don't know what to use except for the historical average return. The problem is historical average return is the number whose deviation from the two expected value has a big variance. You just don't get a lot of information, even with a huge sample of data about what the true expected market return is. So I think the market return from back to 26 to now return in access for rate has been in the neighborhood of maybe four to 5%. But the uncertainty on that numbers means that two standard deviations away could be much closer to zero or much, much higher. Even though you have now almost 100 years of data on this, you still don't get a very precise estimate of the expected value. That's a fact of life in investing that there's just no way to get around to that, to handle it in any better way. We just don't know the expected premium of stocks over bills, for example.

Interviewer: And what about the expected factor premiums?

Fama: Same thing. Because as long as you have stock returns in there, the variance associated with them is going to be very high. So the expected values of any premiums that you put in are always very uncertain, no matter how much data you have. Or another way to think about it is you'll never get enough data to know that for certain you'll get a positive, expected, premium. Even if I tell you the expected value of the premium, you don't know that in any finite simple, you will get that because the variance is so high.

Interviewer: Yeah. And we don't know the expected value. So it's a-

Fama: So it's a double premium, right?
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by PicassoSparks »

vineviz wrote: Sun May 15, 2022 4:39 pm I'm not sure I understand this criticism. Fama has spent virtually his entire academic career examining "exceptions", "aberrations", etc.
The idea that there might be systematic deviations from EMH is not some fringe idea, even if Fama is unwilling to consider it.

Behavioral economics is a well-respected competing set of explanations for the empirical evidence. As Thaler and Fama say in the video I linked, there is large amounts of overlap in their understanding of the workings of markets, but that is a far cry from every bit of evidence supporting EMH. Moreover, if you are willing to go a little further from the economic mainstream, you run into Mandelbrot’s critique of Fama’s work which is still well in the realm of disputable science.

I commend Dr Fama for his contributions to the field, but it’s a mistake to presume that the science is settled on EMH.

I suppose the science will continue to advance, one funeral at a time.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by vineviz »

PicassoSparks wrote: Sun May 15, 2022 5:44 pm
vineviz wrote: Sun May 15, 2022 4:39 pm I'm not sure I understand this criticism. Fama has spent virtually his entire academic career examining "exceptions", "aberrations", etc.
The idea that there might be systematic deviations from EMH is not some fringe idea, even if Fama is unwilling to consider it.
Fama has not only considered it, he's observed it and commented about it.

I'll say it again, I don't really understand the animosity EMH engenders.

And don't get me started on Mandelbrot or Taleb.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by billaster »

So ...

Every. Bit. of Evidence. supports the Efficient Market Hypothesis ...

... except for the evidence that contradicts the Efficient Market Hypothesis.

Okay, then.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by PicassoSparks »

vineviz wrote: Sun May 15, 2022 5:54 pm I'll say it again, I don't really understand the animosity EMH engenders.
Well in my case, it was that you are consistently one of the best posters on this website and it was jarring to see you appear to overstate the degree to which EMH is supported in the evidence.
vineviz wrote: Sun May 15, 2022 1:44 pm Every bit of evidence we have about the way that markets work tells us the they are efficient.

Every.

Bit.
This just isn’t true.
vineviz wrote: Sun May 15, 2022 2:58 pm Virtually every student of markets acknowledges that most markets, most of the time, are incredibly efficient at pricing in available information, preferences, and restrictions.
This is.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by LTCM »

vineviz wrote: Sun May 15, 2022 5:54 pm And don't get me started on Mandelbrot or Taleb.


Oh please do. It took me 300+ pages of that book before I realized how disingenuous he is. I can't think of book I've got closer to the end of and not finished. No sunk cost fallacy for me!
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by vineviz »

PicassoSparks wrote: Sun May 15, 2022 7:11 pm
vineviz wrote: Sun May 15, 2022 1:44 pm Every bit of evidence we have about the way that markets work tells us the they are efficient.

Every.

Bit.
This just isn’t true.
vineviz wrote: Sun May 15, 2022 2:58 pm Virtually every student of markets acknowledges that most markets, most of the time, are incredibly efficient at pricing in available information, preferences, and restrictions.
This is.
Those two statements are 100% consistent with each other.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by 000 »

The EMH is like one of those drawings where some see a rabbit and others see a duck. :mrgreen:
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by DonIce »

Regarding international investing, I think Fama is correct regarding expropriation risk and I made the same argument here:

viewtopic.php?p=6663343#p6663343
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by folkher0 »

nisiprius wrote: Sun May 15, 2022 5:01 pm
folkher0 wrote: Sat May 14, 2022 5:11 pm...FWIW the “international” question occupied very little of the episode. Frankly it seemed more like a footnote...
I thought this was important. I won't call it a bombshell, but it certainly confirms my own skeptical ideas. My underlining.
Interviewer: What do you think makes sense to use as an estimate for expected stock returns, just market returns?

Fama: Okay. That's a very good question because I don't know what to use except for the historical average return. The problem is historical average return is the number whose deviation from the two expected value has a big variance. You just don't get a lot of information, even with a huge sample of data about what the true expected market return is. So I think the market return from back to 26 to now return in access for rate has been in the neighborhood of maybe four to 5%. But the uncertainty on that numbers means that two standard deviations away could be much closer to zero or much, much higher. Even though you have now almost 100 years of data on this, you still don't get a very precise estimate of the expected value. That's a fact of life in investing that there's just no way to get around to that, to handle it in any better way. We just don't know the expected premium of stocks over bills, for example.

Interviewer: And what about the expected factor premiums?

Fama: Same thing. Because as long as you have stock returns in there, the variance associated with them is going to be very high. So the expected values of any premiums that you put in are always very uncertain, no matter how much data you have. Or another way to think about it is you'll never get enough data to know that for certain you'll get a positive, expected, premium. Even if I tell you the expected value of the premium, you don't know that in any finite simple, you will get that because the variance is so high.

Interviewer: Yeah. And we don't know the expected value. So it's a-

Fama: So it's a double premium, right?

I agree with you. This section was the most interesting part of the interview.

The more I read and listen to Fama and French the less convinced I am that factor based investing is something either expect to actually generate higher risk adjusted returns in the time frame of a typical investor. Both seem pretty humble about the practicality of capturing the premiums identified in their models.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by JackoC »

nisiprius wrote: Sun May 15, 2022 5:01 pm
folkher0 wrote: Sat May 14, 2022 5:11 pm...FWIW the “international” question occupied very little of the episode. Frankly it seemed more like a footnote...
I thought this was important. I won't call it a bombshell, but it certainly confirms my own skeptical ideas. My underlining.
Interviewer: What do you think makes sense to use as an estimate for expected stock returns, just market returns?

Fama: Okay. That's a very good question because I don't know what to use except for the historical average return. The problem is historical average return is the number whose deviation from the two expected value has a big variance. You just don't get a lot of information, even with a huge sample of data about what the true expected market return is. So I think the market return from back to 26 to now return in access for rate has been in the neighborhood of maybe four to 5%. But the uncertainty on that numbers means that two standard deviations away could be much closer to zero or much, much higher. Even though you have now almost 100 years of data on this, you still don't get a very precise estimate of the expected value. That's a fact of life in investing that there's just no way to get around to that, to handle it in any better way. We just don't know the expected premium of stocks over bills, for example.

Interviewer: And what about the expected factor premiums?

Fama: Same thing. Because as long as you have stock returns in there, the variance associated with them is going to be very high. So the expected values of any premiums that you put in are always very uncertain, no matter how much data you have. Or another way to think about it is you'll never get enough data to know that for certain you'll get a positive, expected, premium. Even if I tell you the expected value of the premium, you don't know that in any finite simple, you will get that because the variance is so high.

Interviewer: Yeah. And we don't know the expected value. So it's a-

Fama: So it's a double premium, right?
Good that a renowned researcher would say that so more people accept it, but it's pretty obvious IMO especially in the usual context here, multi-decade periods as in retirement investing. The past sample is quite small in terms of multi-decade non-overlapping periods (overlapping periods is junk statistics). Any conclusion drawn is inherently fairly weak even assuming the statistical distribution of returns is stationary which it's pretty clearly not. I wouldn't despair at that and lose interest in looking at past relationships but I would realize skeptics of apparently exploitable market anomalies are always going to have some reasonable ground for their skepticism.

On EMH as it relates to the thread title subject of international, I think it was said in an earlier post: the hypothesis that foreign markets might be priced unfavorably for US investors doesn't necessarily say anything about EMH. We don't need to doubt market efficiency to say municipal bonds as priced in the market are less suitable for low than high marginal tax bracket investors. The efficient market clearing price doesn't have to suit everyone. That said I'd repeat I don't much buy the briefly stated hypothesis of Fama's about non-US stocks, that expropriation risk makes them a measurably worse deal for investors outside that country. I really doubt it's of significance among major developed markets. Somebody mentioned soft expropriation via govt pressure on companies to subordinate shareholder interest to other 'stakeholders' but that's generally just against shareholders, not foreign shareholders particularly. And the market knows it's been more true in reality in Europe say than the US, also knows more lip service is paid to it ('stakeholder capitalism') lately in the US, but who can say the *unexpected* (not already priced in) harm to shareholders from 'stakeholder capitalism' will be less in the US, from here on, than elsewhere? Diversify, I would say. I think Fama's hypothesis might have limited application in some EM's.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Massdriver »

According to the quotes above, it’s not just factors that don’t have enough data to support the premium. He spoke just before factors about the uncertainty of equities outperforming bonds. He’s right of course that there’s no way of knowing based on the limited data we have what the equity risk premium or factor premiums will be if anything at all. I personally will purchase equities expecting them to outperform. Similarly, I will continue tilting to factor funds. If one were to embrace the skepticism of not knowing about premiums, then it implies to invest all of one’s money in treasuries. I would rather be a little more optimistic. :happy
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Northern Flicker »

An investor has more reliable remedies available if using the court system of their home country, so there is an argument to be made that the stocks of some non-US stock are riskier for a U.S. resident than for a resident of the other country in question.

However, a US-only portfolio takes the lower expropriation risk of a single country. A total int’l index fund diversifies the higher expropriation risk across many countries. As a result, it is very difficult at best to quantify the relative expropriation risk between a U.S. equity portfolio, and say a total int’l index fund.

Suppose, for the sake of discussion, each country in an int’l index has double the expropriation risk of the U.S. for a U.S. investor. Suppose also that the expropriation risk of each country in the int’l index is independent of the others in the index. These assumptions may not be correct, but in this contrived example, a US portfolio has a much higher expected loss from expropriation.

I take that as evidence that the assumptions of the example are indeed not correct, but it nonetheless illuminates the difficulty of quantifying the relative expropriation risk of the two investments.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Northern Flicker »

The GameStop saga did not necessarily violate EMH. Lots of buy sentiment was shared publicly and together with the fact that there was a substantial short position it got priced in. It would take a deep dive into all of the trades to decide if EMH was contradicted, and that may be inconclusive.

But the point of EMH is that it is a general principle that can help investors be successful. You generally are more likely to be successful with strategies that assume EMH is true than with strategies that require it to be false.

Fama & French have a factor model that incorporates momentum. I believe that there can only be a momentum premium if EMH is false. Or, is there some explanation for the supposed momentum factor that is consistent with EMH?
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by 000 »

This EMH is starting to sound more and more like an Unfalsifiable Hypothesis to this observer. :P

Another one for the good ol' Bucket o' Tautologies, I guess, eh? :mrgreen:
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Northern Flicker »

000 wrote: Mon May 16, 2022 12:37 am This EMH is starting to sound more and more like an Unfalsifiable Hypothesis to this observer. :P

Another one for the good ol' Bucket o' Tautologies, I guess, eh? :mrgreen:
Newtonian mechanics did not work for atomic particles. It still is useful. EMH is a useful theory. It is known to fail when for insufficiently liquid assets. In that sense, it perhaps could be considered to be falsified already from a mathematical perspective.

But that just means that pre-conditions need to be tightened. Scientific theories are revised all the time when evidence undermines the theory as stated. This is part of the process of understanding. That type of evolution is unlikely to happen with EMH because it is useful as-is, and unlikely to be made more useful for investors from such an evolution.

What EMH definitely is not is a mathematical conjecture to be proven or disproved.
Last edited by Northern Flicker on Mon May 16, 2022 6:29 pm, edited 1 time in total.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Seasonal »

Interviewer: And what about the expected factor premiums?

Fama: Same thing. Because as long as you have stock returns in there, the variance associated with them is going to be very high. So the expected values of any premiums that you put in are always very uncertain, no matter how much data you have. Or another way to think about it is you'll never get enough data to know that for certain you'll get a positive, expected, premium. Even if I tell you the expected value of the premium, you don't know that in any finite simple, you will get that because the variance is so high.
Stocks are expected to generate higher returns because they are risky. If you knew you would be getting the higher return (over any given time frame) then they wouldn't be risky, violating the premise. It's not so much a lack of data (although that's important); it's basic finance.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Seasonal »

000 wrote: Mon May 16, 2022 12:37 am This EMH is starting to sound more and more like an Unfalsifiable Hypothesis to this observer. :P

Another one for the good ol' Bucket o' Tautologies, I guess, eh? :mrgreen:
It's a nice simple way of explaining why you are not going to do better than the market by trying to take advantage of facts that are publicly available or analysis that is easily available, at least without being lucky. To say that your reasons for making an investment decision are already priced and therefore unlikely to beat the market is useful, whatever the technical details or accuracy of EMH.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by JackoC »

Northern Flicker wrote: Mon May 16, 2022 12:00 am An investor has more reliable remedies available if using the court system of their home country, so there is an argument to be made that the stocks of some non-US stock are riskier for a U.S. resident than for a resident of the other country in question.

However, a US-only portfolio takes the lower expropriation risk of a single country. A total int’l index fund diversifies the higher expropriation risk across many countries. As a result, it is very difficult at best to quantify the relative expropriation risk between a U.S. equity portfolio, and say a total int’l index fund.

Suppose, for the sake of discussion, each country in an int’l index has double the expropriation risk of the U.S. for a U.S. investor. Suppose also that the expropriation risk of each country in the int’l index is independent of the others in the index. These assumptions may not be correct, but in this contrived example, a US portfolio has a much higher expected loss from expropriation.

I take that as evidence that the assumptions of the example are indeed not correct, but it nonetheless illuminates the difficulty of quantifying the relative expropriation risk of the two investments.
I agree and what I was suggesting about even EM expropriation risk biased against foreign holders, something actually significant. I'm unconvinced expropriation biased against foreign holders is even much of a risk among DM's (no risk is literally zero). DM expropriation generally comes in the 'soft' form of regulations or civil societal pressure to subordinate shareholder interests to other interests. But that soft form doesn't usually single out foreign shareholders. With EM, outright anti-foreign expropriation is more of a real risk, but as you say diversified across a bunch of them. Although one could debate if the risk is so much higher in all of them than in the US that it's still reduces expected return to take that risk from US POV (which is also assuming the risk of expropriation of foreigners is mispriced from POV of a US investor, possible even if the market is efficient though OTOH has just been hypothesized, not demonstrated).

And besides, there's every other US-specific risk you aren't diversifying by being US-only. A salient feature of 'Anglo-Saxon capitalism' in recent times is 'hollowing out' the economy in which the multi-national is domiciled by ruthlessly seeking cost advantage in sourcing each input. All global big caps do that but US ones probably more and it's probably IMO a significant ingredient in US stocks doing better in recent times (how it's impacted US society is a different debate, for someplace else). But there's no assurance that approach will outperform rather than underperform market expectations from here on. Political forces may constrain it more, other countries' companies may do it more, the largely duopolistic tech business (a lot of tech market cap is either in US, China or countries right near China which will he heavily influenced by it) may shift in China's favor: myriad possibilities why US stocks might underperform without 'disaster' necessarily (or could still overperform, if you knew which you would not diversify). You don't have to be an EMH true believer to think that recent past US outperformances is largely priced in, you have to believe in gross market inefficiency to think it isn't.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by TxFrog »

I’ve always viewed the EMH in the context of the Law of Large Numbers or the Central Limit Theorem. That is, I view the EMH as it applies to the whole market over my investment horizon, not individual stocks over short periods of time

VTI/VTSAX has over 4,000 stocks. There are always going to be a handful of stocks whose valuations are difficult to rationalize using available information (e.g GME, AMC, etc.). However, as you sample thousands of stocks over thousands of trading days (long term investment horizon), the valuation of the U.S. stock market should be approximately “efficient”.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by billaster »

000 wrote: Mon May 16, 2022 12:37 am This EMH is starting to sound more and more like an Unfalsifiable Hypothesis to this observer. :P
It is certainly unprovable as Fama states in his Joint Hypothesis Problem. The Efficient Market Hypothesis says that it is impossible for rational investors to profit consistently on market anomalies. But this theory can only be tested against another model of asset pricing as to what is or is not a pricing anomaly. There is no way to tell if the EMH is wrong or the competing model is wrong on pricing relative to each other.

Basically it comes down to deciding whether a successful investor is skillful or just lucky. The believer in the EMH says it is luck. The believer in inefficient markets says it is skill. You can't prove either way.

So the Efficient Market Hypothesis will always just be an hypothesis, a model that may or may not be useful in various circumstances.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Seasonal »

billaster wrote: Mon May 16, 2022 9:31 am
000 wrote: Mon May 16, 2022 12:37 am This EMH is starting to sound more and more like an Unfalsifiable Hypothesis to this observer. :P
It is certainly unprovable as Fama states in his Joint Hypothesis Problem. The Efficient Market Hypothesis says that it is impossible for rational investors to profit consistently on market anomalies. But this theory can only be tested against another model of asset pricing as to what is or is not a pricing anomaly. There is no way to tell if the EMH is wrong or the competing model is wrong on pricing relative to each other.

Basically it comes down to deciding whether a successful investor is skillful or just lucky. The believer in the EMH says it is luck. The believer in inefficient markets says it is skill. You can't prove either way.

So the Efficient Market Hypothesis will always just be an hypothesis, a model that may or may not be useful in various circumstances.
I don't believe EMH says skill is impossible or just luck. Rather, skill is rare and identifying it in advance is not possible absent luck. Also, managers and advisors who might have skill tend to charge enough that their clients don't benefit after charges. Alas, managers and advisors without skill also charge for their services.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by drumboy256 »

If EMH was correct, everyone on this board would buy VT instead of VTI. Alas.....
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Seasonal »

drumboy256 wrote: Mon May 16, 2022 10:23 am If EMH was correct, everyone on this board would buy VT instead of VTI. Alas.....
That does not follow from EMH. There are definitely individual differences that may suggest different investment choices.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by alluringreality »

TxFrog wrote: Mon May 16, 2022 9:12 am I’ve always viewed the EMH in the context of the Law of Large Numbers
Thanks for posting. I'll suppose law of large numbers might also come into play with differing opinion about a one-time lump-sum investment compared to investing across time. I just tend to expect that generally unknowns are not necessarily the same between a single point compared to lots of points across time. The concept of Knightian Uncertainty seems to endorse a similar line of thought, where a single point seems classified as merely estimation.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by garlandwhizzer »

The market errs from time to time, as do we all. Sometimes laughably so, as we see with some growth tech darlings like ARKK, MEME, TSLA, BTC, etc., whose excessive valuations are built on future narrative in the absence of supporting fundamentals. Quite simply, the future is not required to fulfill optimistic future narratives. Once over-hyped stock prices start skyrocketing, MOM investors pile on board. It becomes a self-reinforcing cycle until the music stops playing which it has.

The problem is that a tiny proportion of the over-hyped stocks like AMZN turn out to be incredibly incredibly great long term investments. That is the very effective bait that attracts future narrative lovers. The problem is prospectively separating the rare wheat from the abundant chaff in high growth names. No one does that well. Cathie Wood believes the current disaster in ARKK stocks is, "the greatest misallocation of capital in the history of the stock market." Right now, the market thinks otherwise although it did take its time to arrive at this point of view.

Clearly, the EMH sometimes departs from reality. The market creates short/intermediate term bubbles in growth stocks occasionally, but it also at some point self-corrects those errors. That process is going on right now. Most of the current equity market damage has been done to the excessively priced tech/growth darlings and IMO, the damage is likely not over yet. Those who have had maintained significant value exposure have suffered considerably less. Cap weight indexes if they are dominated by mega-cap growth is that it they too are vulnerable. If TSM investors were concerned sufficiently by that, they had the option to switch some amount of overpriced TSM to cheaper SCV. On the other hand if your portfolio was dominated by SCV for the last 10 - 15 years, you also suffered a long period of underperformance relative to cap weight indexes.

There are market cycles that reward growth investing greatly for years then abruptly punish it. There are also eras in which value underperforms for many years running and then suddenly skyrockets, making up those losses and more. Timing these abrupt changes in market sentiment is easy to do in retrospect when it seems obvious. It is, however, not reliably done by anyone I am aware of prospectively. We deal in probabilities only, not certainty.

The EMH and cap weight indexing show flaws from time to time, as do all investing methods that I am aware of. We do not live in a perfect investing world. All investing theories and all active investing approaches are also flawed from time to time. This is yet another reason for those of us who don't like volatility to remain widely diversified.

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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by neurosphere »

TxFrog wrote: Mon May 16, 2022 9:12 am I’ve always viewed the EMH in the context of the Law of Large Numbers or the Central Limit Theorem. That is, I view the EMH as it applies to the whole market over my investment horizon, not individual stocks over short periods of time

VTI/VTSAX has over 4,000 stocks. There are always going to be a handful of stocks whose valuations are difficult to rationalize using available information (e.g GME, AMC, etc.). However, as you sample thousands of stocks over thousands of trading days (long term investment horizon), the valuation of the U.S. stock market should be approximately “efficient”.
Exactly! It's the "good luck predicting the next Enron, the next gamestop, etc. consistently over your investment career" and making more money than not attempting to make such predictions. That's it.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Northern Flicker »

drumboy256 wrote: Mon May 16, 2022 10:23 am If EMH was correct, everyone on this board would buy VT instead of VTI. Alas.....
That is not correct. EMH does not require holding every asset class, nor does it require allocating to asset classes at relative weights corresponding to market cap ratios.
Last edited by Northern Flicker on Mon May 16, 2022 10:08 pm, edited 1 time in total.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Gaston »

VTI wrote: Sat May 14, 2022 7:12 am The reason given in the podcast, which unlikely to be his only reason, is that that expropriation risk is not adequately reflected in the price of stocks.
Having lived and worked in a number of emerging market countries, I agree with this view. Expropriation, whether by direct nationalization of assets, devaluation of a currency, the imposition of exchange controls, or by various other means is not uncommon, particularly in dictatorial regimes.

To share just one anecdote from what I’ve witnessed: A well-connected general might see a business and think, “hmm, this could be a good business for my son.” A couple days later, government health and tax inspectors show up at the business and “discover” a litany of violations. A short while later, the son is running the business, having obtained it at a fire sale price. And yes, this applies to publicly-listed, shareholder-owned companies.

If you wish to invest abroad (which I do), IMHO it is much safer to invest in developed, democratically-governed nations.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by drumboy256 »

Northern Flicker wrote: Mon May 16, 2022 6:27 pm
drumboy256 wrote: Mon May 16, 2022 10:23 am If EMH was correct, everyone on this board would buy VT instead of VTI. Alas.....
That is not correct. EMH does not require holding every asset class, nor does it require holding assets classes at relative weights corresponding to market cap ratios.
I’m not saying EMH is reliable even as a barometer for market conditions. Besides that, most of the thought around these parts is pretty maximalist anyways.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by pascalwager »

pascalwager wrote: Sat May 14, 2022 3:30 pm
Oregano wrote: Sat May 14, 2022 3:08 pm
VTI wrote: Sat May 14, 2022 9:03 am
vineviz wrote: Sat May 14, 2022 8:02 am It also implicitly assumes that expropriation risk is non-existent if you invest exclusively in stocks listed in your home country, which many investors can tell you from experience is not true.
I don't believe he's implicitly assuming this. Instead, he's assuming that the risk of expropriation is higher for foreign investors than domestic investors. I don't think that's an unreasonable assumption.
But still, the question is not whether the risk is higher, but whether or not it is being priced appropriately. Fama claims to know the answer, but he's full of it. No one knows how much is being priced in, and no one can reliably predict the probability of expropriation.

If you take the recent problematic issues with Russian stocks (not expropriation, at this time, but severely restricted)...well, Russian stocks did actually trade at very low valuations compared to most of the world BEFORE the invasion of Ukraine. So it seems like investors did appreciate a lot of excess risk in owning Russian stocks, but of course they could not have predicted exactly what or when something might happen.

Finally, as others have pointed out, there are a large number of risks in investing, so the idea that you should choose your investments solely based on one factor is a pretty weak argument. And I can imagine a not-too-distant future in the U.S. where expropriation, or other valuation-reducing scenarios, become a real concern - and the U.S. stock market is not pricing in this risk AT ALL. It seems that Fama, like most mortals, is falling into the trap of looking backwards instead of forward.
Yes, a good point you make. And the US has recently expropriated $300 million dollars in Russian assets.
Correction: $300 billion, not "million".
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by ScubaHogg »

Northern Flicker wrote: Mon May 16, 2022 12:47 am
000 wrote: Mon May 16, 2022 12:37 am This EMH is starting to sound more and more like an Unfalsifiable Hypothesis to this observer. :P

Another one for the good ol' Bucket o' Tautologies, I guess, eh? :mrgreen:
EMH is a useful theory.
They should rename it EMT if it’s being upgraded to a “theory.” The “H” seems more accurate to me though.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by pascalwager »

I've decided that there's no way to reduce the threat of expropriation if I hold stocks, so I'm not going to reduce my international allocation (currently 41%).

The New World Order has informed us that we (the non-elite) are going "to own nothing", and I assume that includes investments. So any adjustments we make now are immaterial, unless we're trying to maximize the purchase of hard assets in order to live a separate, parallel life outside the cities.

Right now, in Europe and the US, the expropriation seems to be taking the form of purposeful economic destruction, so direct expropriation may not be necessary.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Seasonal »

Gaston wrote: Mon May 16, 2022 8:52 pm
VTI wrote: Sat May 14, 2022 7:12 am The reason given in the podcast, which unlikely to be his only reason, is that that expropriation risk is not adequately reflected in the price of stocks.
Having lived and worked in a number of emerging market countries, I agree with this view. Expropriation, whether by direct nationalization of assets, devaluation of a currency, the imposition of exchange controls, or by various other means is not uncommon, particularly in dictatorial regimes.

To share just one anecdote from what I’ve witnessed: A well-connected general might see a business and think, “hmm, this could be a good business for my son.” A couple days later, government health and tax inspectors show up at the business and “discover” a litany of violations. A short while later, the son is running the business, having obtained it at a fire sale price. And yes, this applies to publicly-listed, shareholder-owned companies.

If you wish to invest abroad (which I do), IMHO it is much safer to invest in developed, democratically-governed nations.
The question is not whether there's a high risk of expropriation; the question is whether the risk is adequately reflected in the market price. The first does not imply the second.
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Re: Eugene Fama (Fama–French 3-factor model; EMH): Americans don't need to bother w/ international investing

Post by Northern Flicker »

ScubaHogg wrote: Tue May 17, 2022 9:54 am
Northern Flicker wrote: Mon May 16, 2022 12:47 am
000 wrote: Mon May 16, 2022 12:37 am This EMH is starting to sound more and more like an Unfalsifiable Hypothesis to this observer. :P

Another one for the good ol' Bucket o' Tautologies, I guess, eh? :mrgreen:
EMH is a useful theory.
They should rename it EMT if it’s being upgraded to a “theory.” The “H” seems more accurate to me though.
I think renaming it to a theory would be appropriate.
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