3 Market Trends & Asset Pricing Scholars Win Nobel Prize

Market Trends & Asset Pricing Scholars Win Nobel Prize
Americans Eugene Fama, Lars Peter Hansen and Robert Shiller won the Nobel prize for economics on Monday for developing new methods to study trends in asset markets.

The Royal Swedish Academy of Sciences said that through their separate research, the three had laid the foundation of the current understanding of asset prices.  Fama and Shiller "provide the ends of the spectrum" between those who believe financial markets are efficient and those who think them deeply flawed, with Hansen "in the middle doing the math," said Allen Sanderson, a University of Chicago lecturer in economics.  American researchers have dominated the economics awards in recent years; the last time there was no American among the winners was in 1999.  Eugene Fama and Lars Peter Hansen of the University of Chicago and Robert Shiller of Yale University were honored for shedding light on the forces that move stock, bond and home prices - findings that have transformed how people invest.  "Their methods have shaped subsequent research in the field, and their findings have been highly influential both academically and practically," the Royal Swedish Academy of Sciences said in Stockholm.

Starting in the 1960s, Fama and others showed how difficult it is to predict stock prices in the short run, findings which changed market practice, for example with the emergence of index funds, the academy said.  Two decades later, Shiller showed that there is more predictability in the long run in stock and bond markets, while Hansen developed a statistical method to test theories of asset pricing.  "These findings, which might seem surprising and contradictory, were made and analyzed by this year's laureates," the academy said.  "These are three very different kinds of people and the thing that unites them all is asset pricing," says David Warsh, who tracks academic economists on his Economic Principals blog.  While it's hard to predict whether stock or bond prices will go up or down in the short term, it's possible to foresee movements over periods of three years or longer, the academy said.

Fama's research revealed the efficiency of financial markets: They absorb information so fast that individual investors can't outperform the markets as a whole. His work helped popularize index funds, which reflect an entire market of assets, such as the Standard & Poor's 500 stock index.  "Fama's work was incredibly fundamental in the '60s and '70s," said David Warsh, who follows economists at his Economic Principals blog. "It led to enormous practical change in terms of people not buying particular stocks but buying index funds."  Fama's work drew criticism after the financial crisis of 2007-09 seemed to prove that financial markets were anything but efficient. Housing prices, after all, had scaled great heights and then crashed.  But David Backus, an economist at New York University, said "people completely misunderstand" what Fama was arguing.  "He said that information out there will be reflected in (asset) prices. That is completely different from saying financial markets work well," Backus said.

Shiller's research examined asset prices from a contrasting angle. He showed that in the long run, stock and bond markets can behave irrationally, reaching prices that are out of whack with economic fundamentals.  Shiller, 67, predicted the dot-com crash of the early 2000s and the implosion of home prices in 2007. He has also been a pioneer in the field of behavioral economics, or how human emotions, biases and preferences can collectively influence financial markets.  Using mathematical tools like the well-known Case-Shiller index of home prices, Shiller has expanded the available information on asset prices.  Meb Faber, chief investment officer at Cambria Investment Management, said his firm uses a model developed by Shiller to seek stock bargains around the world.

Hansen has focused on statistical models, creating ways to test competing theories of why asset prices move as they do.

Collectively, Fama, Shiller and Hansen didn't create a simple, unified theory of how financial markets work. Rather, they worked like "blind men feeling an elephant" - each finding a bit of the truth in a vast and complicated field, Sanderson said.

Courtesy of Karl Ritter et al, AP Yahoo & Huffington Post.