Fama, Shiller and Billy Beane – A Nobel Prize in Baseball

A couple of days ago it was announced that Eugene Fama, Lars Peter Hansen and Robert Shiller had been awarded the Nobel Prize in economic for their contribution to the understanding of asset prices.

The interesting thing of course is that Fama’s main contribution is the Efficient Market Hypothesis (EMH), while Shiller’s main contribution has been to try to empirically prove that EMH is wrong.

I think most of my readers know that I am mostly in the EMH camp, but also that I in my day-job is in the business of trying to beat the market. So I am a bit split – even though I after years of trying to beat the markets and having obsermtved others trying to do the same thing has come to the conclusion that people do get lucky – sometimes more than once (just look at Shiller!) – but that it is very hard to find anybody who consistently beat the markets. That in my view is the real-world version of EMH. Or said in another way it might be possible to find indicators that will make it possible for you to beat the market in shorter or longer periods, but these indicators eventually breaks down.

Anyway, the Nobel Prize news reminded me of an old post I did on the Oakland A’s. So let me quote a bit from that post. I think it shows why both Fama and Shiller are right.

I have been watching Moneyball. It is a great movie… economics play a huge role in this movie. So that surely made me interested. It is of course very different from Michael Lewis’ excellent book Moneyball, but it is close enough to be an interesting movie even to nerdy economists like myself.

… why bring Moneyball into a discussion about money and markets? Well, because the story of the Oakland A’s is a pretty good illustration that Scott Sumner is right about the Efficient Market Hypothesis (EMH) – even when it comes to the market of baseball players. So bare with me…

And here I should of course also have said that Fama is right.

Back to my old post:

The story about the Oakland A’s is the story about the A’s’ general manager Billy Beane who had the view that the market was under-pricing certain skills among baseball players. By investing in players with these under-priced skills he could get a team, which would be more “productivity” than if he had not acknowledged this under-pricing. Furthermore as other teams did not acknowledge this he would increase his chances of winning even against teams with more resources. It’s a beautiful story – especially because theory worked. At least that is how it looked. In the early 2000s the Oakland A’s had much better results than should have been expected given the fact that the A’s was one the teams in the with the lowest budgets in the league. The thesis in Moneyball is that that was possible exactly because Billy Beane consistently used of Sabermetrics – the economics of Baseball.

Whether Lewis’ thesis correct or not is of course debatable, but it is a fact that the Oakland A’s clearly outperformed in this period. However, after Moneyball was published in 2003 the fortune of the Oakland A’s has changed. The A’s has not since then been a consistent “outperformer”. So what happened? Well, Billy Beane was been beaten by his own success and EMH!

So Billy Beane was the Robert Shiller of baseball. He found a way to beat the market! But success was, however, not forever – again back to my old post:

Basically Billy Beane was a speculator. He saw a mis-pricing in the market and he speculated by selling overvalued players and buying undervalued players. However, as his success became known – among other things through Lewis’ book – other teams realised that they also could increase their winning chances by applying similar methods. That pushed up the price of undervalued players and the price of overvalued player was pushed down. The market for baseball players simply became (more?) efficient. At least that is the empirical result demonstrated in a 2005-paper An Economic Evaluation of the Moneyball Hypothesis“ by Jahn K. Hakes and Raymond D. Sauer. Here is the abstract:

Michael Lewis’s book, Moneyball, is the story of an innovative manager who exploits an inefficiency in baseball’s labor market over a prolonged period of time. We evaluate this claim by applying standard econometric procedures to data on player productivity and compensation from 1999 to 2004. These methods support Lewis’s argument that the valuation of different skills was inefficient in the early part of this period, and that this was profitably exploited by managers with the ability to generate and interpret statistical knowledge. This knowledge became increasingly dispersed across baseball teams during this period. Consistent with Lewis’s story and economic reasoning, the spread of this knowledge is associated with the market correcting the original mis-pricing.”

Isn’t it beautiful? The market is not efficient to beginning with, but a speculator comes in and via the price system ensures that the market becomes efficient. This is EMH applied to the baseball market. Hence, if a market like the baseball market, which surely is about a lot more than making money can be described just remotely as efficient why should we not think that the financial markets are efficient? In the financial markets there is not one Billy Beane, but millions of Billy Beanes.

Every bank, every hedgefund and every pension fund in the world employ Billy Beane-types – I am one of them myself – to try to find mis-pricing in the financial markets. We (all the Billy Beanes in the financial markets) are using all kind of different methods – some of them very colourful like technical analysis – but the aggregated result is that the markets are becoming more efficient.

Like Billy Bean the speculators in the financial markets are constantly scanning the markets for mis-priced assets and they are constantly looking for new methods to forecast the market prices. So why should the financial markets be less efficient than the baseball market? I think Scott is right – EMH is a pretty good description of the financial markets or rather I haven’t seen any other general theory that works better across asset classes.

So yes Fama and Shiller both deserve the Nobel Prize (as do Lars Peter Hansen), but I don’t believe that Robert Shiller is better at forecasting than the markets in general and I would certainly not think that regulators are better at forecasting than the market!

Leave a comment


  1. John S

     /  October 16, 2013

    Interestingly, Beane’s A’s have made the playoffs for the last two years (although they were bounced both times). Part of the reason for this success may be Beane’s reversal towards drafting more high school players (who in his view became undervalued in the post-Moneyball emphasis on college players).

    This may be his greatest success–outhustling the league even after giving up his trade secrets. Baseball-wise, the end result might be an optimal mixture of gambling on long shots (high school) + going with more proven entities (college). I’m sure a lot of baseball front offices are discussing such a mixed strategy approach to the draft.

  2. I find Fama’s award highly questionable. To my knowledge, most of the stuff that made him famous was either known in advance or refuted hence, sometimes by himself:
    1) He gets credited for the finding that finacial markets are unpredictable? Has everybody forgotten about Benjamin Graham or Benoit Mandelbrot?
    2) It is a giant (and flawed) leap to go from proving markets’ unpredictability to declaring nice and ordely random walk as Fama has suggested. The latter idea has misled market players into modelling financial risk using the gaussian normal distrubution. To their detriment.
    3) Fama’s EMH theory says that market prices move (only) in response to fundamental news about the assets being priced. But it has been established that markets bounce around even there is no news and often lie still when really important news break. Besides, as Shiller has documented, investors take a lot of clues from the actions of other investors, absent any news about the assets.
    In my opinion, EMH is rather like communism. It has a few appealing features, but only on paper.

  3. Cramer

     /  October 16, 2013

    Lars: Technical Analysis beats Macro Analysis any day of the week and you know it ! 😉 What is colourful is Macro guys explaining why their thesis’ and ideas didn’t work this time. Why they always miss the next bull market or couldn’t predict the bear. Always late to the party. Still enjoying your blog though.

  4. Interesting piece Lars. If it’s not possible to beat the market, what’s the incentive of playing?

    Your story seems to lead us to a market that’s constantly becoming more and more efficient-is there a point where it’s now so efficient it can’t be beaten even in the short term? Again, who would play in such a market?

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