“Most of the behavioral finance is just the criticism of efficient markets. So, without me what do they got?”
Eugene Fama
“Gene has it all wrong. If it were not for Behavioral Finance, he and French would have had nothing to do for the past 25 years. He owes me everything.”
Richard Thaler
Although Fama and Thaler are known to be golf buddies and colleagues at the University of Chicago, their differing views on market efficiency and behavioral finance have led to a longstanding academic rivalry. Fama champions Team Efficient Markets, while Thaler captains Team Behavioral Finance, representing conflicting philosophies in the financial market similar to the rivalry between the Lakers and Celtics in basketball.
Team Efficient Markets asserts that market prices are efficient and reflect all available information, making risk-adjusted performance over long periods nearly impossible. This view has evolved to include factor investing, where investors can enhance returns by tilting their portfolios towards specific risk factors. On the other hand, supporters of market efficiency argue that any outperformance is likely due to luck or exposure to unidentified risk factors rather than skill.
In contrast, Team Behavioral Finance believes that while markets are mostly efficient, behavioral biases affect market participants, leading to exploitable inefficiencies that can generate superior risk-adjusted returns. This camp considers ‘risk factors’ to be price/value gaps influenced by behavioral biases rather than increased risk.
Despite the debates over market anomalies and testing difficulties, the philosophies of Fama and Thaler have influenced major asset management firms, such as Dimensional Fund Advisors (DFA) and Fuller & Thaler Asset Management (FullerThaler). While DFA leans towards Fama’s efficient market research and tilts towards specific factors, FullerThaler seeks to exploit behavioral biases for market outperformance.
When comparing the performance of Team Behavioral Finance and Team Efficient Markets over time, evidence suggests that exploiting behavioral biases can lead to superior risk-adjusted returns, challenging the traditional market efficiency hypothesis. However, staunch believers in market efficiency may need to re-evaluate their biases to fully assess the implications of behavioral finance on investment strategies.