Jan 19, 2009
Q & A
The Dow peaked around 14K in October 2007, one year later the Dow went to 7500. Was the market really in equilibrium last October given that it was on the verge of such a steep collapse? How can one address equilibrium given the daily volatility we are experiencing?
EFF: Every market determined price is an equilibrium price that should take account of all information available at the time the price is set. (This is the definition of market efficiency.) But things inevitably change, and equilibrium prices change along with them. All we can say about the recent market turmoil is that the volatility of information and its implications for forecasts of profitability must be quite high.
KRF: Market efficiency does not imply prices cannot change. It does not even say they cannot change by a lot. The key question is whether we should have known the Dow would drop from 14,000 to 7500. Some who made fortunes by anticipating the drop seem to have convinced many observers that the outcome was obvious, but that is just history being written by the victor. Unlike the technology boom of 1999-2000, I don't recall lots of conversations in which people struggled to understand why the Dow was at 14,000.
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ABOUT FAMA AND FRENCH
Eugene F. Fama
The Robert R.
McCormick Distinguished
Service Professor of
Finance at the University
of Chicago Booth School
of Business
Kenneth R. French
The Carl E. and Catherine
M. Heidt Professor of
Finance at the Tuck
School of Business at
Dartmouth College
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Dimensional Fund Advisors Ltd. is authorised and regulated in the United Kingdom by the Financial Services Authority (FRN: 150100), is registered in England and Wales under Company No. 02569601 and VAT No. 577327607. The registered office address of Dimensional Fund Advisors Ltd. is 7 Down Street, London, W1J 7AJ, United Kingdom. Dimensional Fund Advisors Ltd. is a subsidiary of Dimensional Fund Advisors.