Fama and Schiller in brief

Notes from a discussion with a student today, who is doing a senior project in this area:

In "normal market" times the market is very efficient. (But of course not perfectly so.) Fama holds.

Out in the tails, panic and euphoria setting. Paradigms are shifting, and people follow the herd. We see fat-tailed distributions, and in this region Schiller holds.


  1. Interesting, and kind of weird. If stock prices were a random walk, we would not have fat tails, I would think. Do you know of anywhere where he tries to reconcile EM H with fat tails

  2. The other half of that paper is about the EMH itself, so I would expect that's where he reconciles them! But I don't actually know why it should be incompatible with fat tails.

    1. My understanding is EMH implies stock prices are a random walk, while fat tails implies they are not. (A random walk will give you a normal distribution.)

    2. By the way, here is the best principle in the article: "I agree with Gene..."

      Just keep repeating that, TGGP.

  3. I think Fama echoes me here:

    "The reason is that most of what we do in terms of portfolio theory and models of risk and expected return works for Mandelbrot's stable distribution class, as well as for the normal distribution (which is in fact a member of the stable class). For passive investors, none of this matters, beyond being aware that outlier returns are more common than would be expected if return distributions were normal.

    "For other applications, however, the difference can be critical."

    I agree with Gene.

  4. there are many variants of the EMH. some are more strict than others. the random walk is one of the most restrictive and he tends to dismiss it.

    his book is fascinating and really provides insight into how flexible fama really is, despite the common view of him and EMH. it is available for free on his website. it is called foundations of finance. if you want to get into the meat of the argument on EMH, it is in chapter 5, although chapters 1-4 provide a really good statistical overview.