Eugene Fama’s Contribution in the Field of Economics

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Table of Contents

Market efficiency
Asset pricing
Forecasting regression
Macroecomics
Application
Conclusion
Works Cited

Eugene Fama is highly honoured for his fundamental contribution in the field of economics. He got his first undergraduate degree in French from Tufts University in the year 1960. Later, he earned his Master in Business Administration and PhD at the University of Chicago in finance and economics. When he was pursuing his post graduate and doctoral studies he was supervised by Benoit Mandelbrot. He was a lecturer who had spent all his teaching profession at the University of Chicago. During his PhD studies his thesis concluded that the stock price movement are erratic and they take an arbitrary walk. His thesis was published on January 1965 in a business journal entitled “the behaviour of stock market prices”. Eugene Fama fundamental inputs to financial economics make him an economist of choice to many. His developments and investigations in the field of market efficiency are cornerstone in the financial economics. The idea of market efficiency and ways of analyzing and processing information on market are key factors in almost all aspects of current empirical research. Eugene Fama developed analytical methods which are currently used as the benchmark for financial economist in the academic field, administration and policy making. His input has influenced areas of assets evaluation and communal financing which has had extraordinary effects on practical asset management and financial administration in general. The past work of Eugene Fama has always been the lead of financial market research. The essay explores the importance of Eugene Fama inputs in the field of economics, his major input and how they relate to Ecuadorian economy (Fama 23).

Market efficiency

Eugene Fama is termed the father of the proficient market theory; he examined the idea of efficient market basing them on 2008 and 2009 markets concepts. He summarizes the advantages and shortcomings of efficient markets to daily investors. The hypothesis states that “at any given moment, security prices reveal all available information on particular stock or market”. Efficient market hypothesis is a model indicating how markets perform; being a model it is more applicable to some markets than others (Investment Advisor par. 4). It turns speculative business pointless. Fama advocated that powerful market efficiency is not entirely a realistic model for various markets. It all depended on the kind of market and the idea does not follow any pattern. Rather, prices take a random walk trend meaning past prices trend cannot be used to determine future prices trends. From this explanation investors are able to understand that trying to overcome the market is a matter of chance and not skill (Black 78).

Asset pricing

The capital asset pricing model (CAPM) is built on various principles of business. They include nature of prevalence, available investment opportunities and clear indications of measurable predictions on risks and returns. The model is used in approximating the value of equity capital for many businesses and assessing the performance of management portfolio. The asset pricing model is the only fundamental model which is taught in investment courses at Master of Business Administration level. The model is simple and gives pleasing predictions on the way to measure risk and the relationship between the expected returns and risks. Any experiential problem may reflect total failure of the business although the problem may be caused by shortcomings related to the empirical tests (Kirman 32). Eugene Fama’s contribution on the asset pricing brought about an empirical and scientific rigor in the area of investment management and thus changing the way in which people use to view and conduct financial issues. This model has been rated to be very efficient especially in fitting stock data and evaluating the success of management portfolios. The model assumes that the investors are not willing to take risk when choosing portfolio. In choosing the portfolio the investor only care about the mean and variance of the portfolio returns, having in mind the expected returns. The Capital Asset Pricing Model changes algebraic data to a testable prediction on the relationship between risk and the expected returns. This is achieved by choosing a portfolio that must be competent if asset prices are to achieve the clearance of the market of all assets (Fama 17).

Forecasting regression

In the year 1957 Eugene Fama published an empirical document on how to determine inflation using short term interest rates. The concept was expected inflation rate can be used to determine the interest rate. Dependent variable in this case is the interest rate and the independent variable is the expected inflation rate. The concept of regression is used by investors to determine their future returns and to detect any possible occurrence of inflation. With this information they are able to take relevant measure in order to avoid losses in their businesses. Agency problems and the theory of organisation explains how different mechanisms come up to moderate the problems facing the agency. The problems addressed are the ones related to the separation of possession and control of the organization activities. Organization managers are able to device efficient way of dealing with problems which may arise in the business. In doing so they are safeguard their company from any financial crisis that are related to management (Fama 65).

Macroecomics

Money is a key element in every financial organization; it is also the corner stone of economics. In this reference money become a key portfolio asset, and investigation on how borrowing and lending may provoke to different opinions from customers and investors. The differences range from how much money should be used in business transaction to purposes to how pricing of the buying power may risk the money distribution in the perception of the capital asset pricing model. This forms part of Eugene Fama’s contribution to financial economics (Nocera 11).Both customer and investors gain knowledge on how to make transaction that would protect the organization from any financial disaster (Jorge 61).

Application

Ecuador’s economy is basically dominated by petroleum resources, they account for at least halt of country’s export income and one quarter of the public segment revenues. Recently the country suffered economic crisis which adversely affected its GDP levels (Nationmaster.com 1) Ecuadorian can use the market efficiency theory to determine how different markets are doing. Since the theory does not apply to all markets they are able to choose the one that will give them good returns. This also helps in careful selection of trading partners. The Capital Asset Pricing Model to determine the performance of the financial sector. This serves as a fundamental indicator of any financial crisis that may arise, organizations are able to put precautious measures early enough. The best performing market strategy is adopted by the investor for good returns. Theory of macroeconomic would help the country in management of its finances and creation of good business relationship between the customers and investors. In using the concept of forecast regression, any possibilities of inflation are detected early enough. The country is able to put measures to control inflation or to help them cope up with the effects of inflation (Fama 12).

Conclusion

Eugene Fama has made fundamental contributions to the field of financial economics. His developments and investigations in the field of market efficiency are cornerstone in the financial economics. The idea of market efficiency and ways of analyzing and processing information on market are key factors in almost all aspect of current empirical research. Eugene Fama developed analytical methods which are currently used as the benchmark for financial economist in the academic field, administration and policy making. His input has influenced areas of assets evaluation and communal financing which has had extraordinary effects on practical asset management and financial administration in general. Adoption of Eugene Fama’s theories by financial organizations has led to great improvement in their economics returns. His contribution can be used by countries or organizations that are facing economic crisis in order to gain knowledge of resolving their economic crisis. Knowledge on how to predict inflation, management of finances and how to rate the performance of various can be acquired from his contributions.

Works Cited

Black, Jensen. The capital asset pricing model: Some empirical tests in Studies in the Theory of Capital Markets. 1972. New York: Praeger. Print.

Fama, Eugene and French, Kenneth. The Capital Asset Pricing Model: Theory and Evidence. Journal of economic perspective, 18.3(2004):25-43

Fama, Eugene and French, Kenneth. 2009.Web.

Fama, E.F & Miller M.H. The Theory of Finance. New York: Holt, Rinehart, and Winston 1972.

Investment Advisor. The efficient pioneer: Eugene Fama’s contributions to modern finance over. 2000. Web.

“Investment Climate”. OverviewGovernment Support for Foreign Investment Ecuadorian Stock Market Links. 2008. Web.

Jorge, Nascimento A New Synthesis for macroeconomics. 2009. Web.

Kirman, Alan. Economic theory and the crisis. 2009. Web.

“NationMaster.com” Ecuadorian economy statistics. 2003. Web.

Nocera, J. Poking Holes in a Theory on Markets. 2009. Web.

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