by Sridhar Arcot
, 28.10.13
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2013 was awarded to three American financial economists , Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller for their “for their empirical analysis of asset prices". Eugene Fama and Lars Peter Hansen are both from the Booth School of Business, University of Chicago while Robert Shiller is from Yale University. All the three laureates work has furthered our understanding of how financial markets work.
Eugene Fama is known for his work on the efficient market hypothesis, which states that markets are efficient if all relevant information is reflected in prices. This means that if a company announces that its profits in a particular year have gone up, the stock price should rise immediately to take into account this information. The consequence of the efficient market hypothesis is that investors cannot beat the market by picking stocks. This in turn has lead to index investing wherein funds invest in a broad market index rather than pick individual stocks. The expenses of index investing funds are substantially lower than those of actively managed funds, which has lead to greater participation of ordinary investors in the stock market.
Robert Shiller in contrast to Eugene Fama is well known for challenging the established view of efficient markets. In his work, Shiller has pointed out that markets are not always efficient and sometimes move away from what fundamental information predicts leading to asset price bubbles. For e.g. during the dot com boom of the late 1990’s there was great demand for internet stocks and any stock with dot com in its name soared irrespective of its underlying business or revenue generating capacity. Shiller was among the first ones to warn us not only about the dot com bubble but also the more recent housing price bubble.
Lars Peter Hansen in his work has come up with statistical methods, in particular the generalized method of moments (GMM) which has a wide variety of applications. Prominent among the many applications, GMM has been widely used to test relationships in financial markets and asset prices.
Eugene Fama has been tipped to win the Nobel prize for many years. However, after the recent financial crisis, faith in the efficient market hypothesis was at an all time low. Many observers therefore did not expect that the Nobel prize for Economics would be given to financial economists anytime soon. The prize awarding committee seems to be aware of this fact and in the end balanced things out by awarding the prize jointly to two economists Fama and Shiller with contrasting views on the topic.
