Biggest Hoax in Stock Market History, Studies Says

A fatal fallacy in popular stock pricing models, financial products, and investment strategies is scientifically best explained as a hoax and contagion, according to Robert Coleman, Ph.D., based on two recent studies. The fatal fallacy behind the hoax is most prominent in the Three-Factor Model. Dimensional Fund Advisors Inc (DFA) is the pioneer and leader in applying this model to stock equity index funds. Since 1981, DFA has grown to more than $86 billion of assets under management in more than 40 publicly traded U.S. mutual funds, with offices in Santa Monica, Chicago, London, Sydney, and Vancouver.

This is the biggest hoax in stock market history, according to these studies, as measured by six major criteria: number of investors harmed, total cash cost, total net realized cost, geographical spread of harmed persons, duration since first commercial application, and number of professionals in academia and the financial-services industry who are involved.

The three-factor-model Hoax costs investors over $1 billion each year, conservatively estimated, as explained in the two articles published in Indian Journal of Economics and Business in June 2005 and Annals of Economics and Finance in May 2006. The estimate includes excess management fees, not advisor fees, due to which a typical retirement-savings-plan account loses $20,000, and high-net-worth individuals lose much more due to advisor fees and larger investments.

The Three-Factor Model OF RETURN was DESIGNED in 1992 by Eugene F. Fama, professor of finance at the Graduate School of Business at the University of Chicago, and Kenneth R. French, professor of finance at the Tuck School of Business at Dartmouth College. The size- and value-related risk factors and the explained return have embedded price and shares, and this creates vicious circular reasoning. Size is market capitalization. Value is book equity-to-market equity ratio. Mr. Fama is the central figure, effective co-founder, Board member, and Director of Research at DFA. Mr. French is vice president of DFA. Both are revenue-sharing product designers for privately held DFA. Their DFA ownership is unknown.

“The Concealed Fatal fallacy in econometrics is known as circular simultaneity”, says Mr. Coleman. “A circular simultaneity occurs when the same variable appears on both sides of an inferential single-equation model. The Three-Factor Model for stock-portfolio pricing contains four circular simultaneities. Thus, it is pseudo-scientific, logically meaningless, non-interpretable, indeterminate, and scientifically invalid. It cannot be designed to earn superior expected returns higher than the overall stock market as measured by conventional benchmarks.”

Mr. Coleman, Financial economist, taught investments at Southern Methodist University. He holds an M.B.A. from Harvard and a Ph.D. in Political Economy from the University of Texas at Dallas. His dissertation in financial economics is an inquiry into capital market pricing.

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