Fama doubts modern finance, cost of capital estimates

BVWireIssue #174-2
March 8, 2017

The “Father of Modern Finance,” Nobel laureate Eugene Fama (University of Chicago), known for his efficient markets hypothesis and empirical work related to asset pricing, says most asset‐pricing models have failed empirically. In a conversation with Joel Stern, chairman and CEO of Stern Value Management, Professor Fama says that estimating something as apparently simple as the cost of capital remains fraught with difficulty. He dismisses betas for individual stocks as “garbage,” and even industry betas are said to be unstable, “too dynamic through time.” What's more, he says that the wide range of estimates for the market risk premium—anywhere from 2% to 10%—casts doubt on their reliability and practical usefulness. He continues to defend the concept of “efficient markets,” while noting that empirically based asset pricing models such as his (and Ken French’s) “three‐factor” CAPM have produced much better results than the standard CAPM.

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