Well I have just finished my trip down to Santa Monica to learn more about DFA (Dimensional Fund Advisors), and I have lots to share. While their public website is okay, it really doesn’t give you a sense of what DFA is (in my opinion). As such, I’ll be writing about 30 posts or so on DFA over the next few months (some of the posts will be going down tangents), because there is something very special about this outfit that I don’t think is captured in their website.
One of the points raised by Kenneth French (a member of the Board of Directors and the ‘French’ part of the Fama-French 3 Factor Model) was the Grossman-Stiglitz Paradox.
The Grossman-Stiglitz Paradox
If we make the following two assumptions:
1. Prices are right (i.e. the market is efficient)
2. Researching securities costs time and energy
1. If prices ARE right, why would you spend time and energy researching securities?
2. If prices ARE right, and therefore you DON’T spend time and energy researching securities, then how did prices get right in the first place?
It is an interesting paradox, and actually is a knock on the strong form of efficient market hypothesis. I suppose that Dr. French’s discussion of this paradox in itself is a bit paradoxical on the surface since Fama and French believe in passive investing through DFA. However, Dr. French indicated that one possible solution is that there have to be only enough mispricings to tempt people into expending this time and energy. They believe this to be a futile endeavour – the reasons for which will be covered in future posts.