Three U.S. economists recently joined the esteemed ranks of Nobel laureates, one of whom has been credited as a founding father of exchange traded fund indexing.
“Beginning in the 1960s, Eugene Fama and several collaborators demonstrated that stock prices are extremely difficult to predict in the short run, and that new information is very quickly incorporated into prices,” according to Nobel. “These findings not only had a profound impact on subsequent research but also changed market practice. The emergence of so-called index funds in stock markets all over the world is a prominent example.”
Many other notable authors on index funds also accredits Fama’s work in indexing and the way he has shaped investing on Wall Street, reports Victor Reklaitis for MarketWatch.
For instance, Mark Hebner, author of “Introduction to Index Funds: The 12-Step Recovery Program for Active Investors,” writes about how Fama took the Random Walk Theory of stock market prices “to new heights with enough rigorous statistical analysis to shake up Wall Street.
Random Walk Theory refers to the idea that past movement or stock price trends are not an indicator for future predictions.
Specifically, Fama’s Efficient Markets Hypothesis, in conjunction with the Random Walk Theory, has helped propel passive investing. The Efficient Markets Hypothesis argues that it is impossible to “beat the market” since stocks always trade at fair value.
“These two theories gave a sucker punch to active managers who think they can outperform the market. … Because they attacked the basic foundations of the investing business, these ideas were slow to gain acceptance on Wall Street,” Lawrence Carrel said in “ETFs for the Long Run.”
Passively index-based ETFs, like the name suggests, are a group of investments that passively track an underlying index, leaving active management out of the equation. [Understanding ETF Portfolio Indexing]
For more information on ETF indices, visit our indexing category.
Max Chen contributed to this article.
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