By Justin Nalos
On October 14, the Royal Swedish Academy of Sciences announced three winners for the Nobel Memorial Prize in Economic Sciences: Eugene F. Fama and Lars Peter Hansen of the University of Chicago and Robert J. Shiller of Yale University. Fama and Shiller are both members of the Phi Beta Kappa Society; Fama was inducted in 1959 at Tufts University, while Shiller was inducted in 1967 at the University of Michigan.
Official known as “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2013,” the Nobel Prize was awarded jointly for the three Laureates’ work in “empirical analysis of asset prices.” The Economic Sciences Prize Committee of the Royal Swedish Academy of Sciences was responsible for selecting the Laureates for the prize. The ten-member committee consisted of six primary members and four associate members and were assisted by appointed expert advisers in the field of economics. According to associate member and Professor of Finance Per Strömberg, the three Laureates’ work together focused on “looking at data and trying to see patterns in financial prices… to predict how financial market prices behave in the future based on information we have today.” The cash prize amount is 8 million SEK, or roughly $1.2 million, split equally among the Laureates.
The Economic Sciences Prize Committee has compiled an article on the scientific background on the research of the three Laureates in asset prices, and it states, “Eugene Fama, Lars Peter Hansen, and Robert Shiller have developed methods toward this end and used these methods in their applied work. Although we do not yet have complete and generally accepted explanations for how financial markets function, the research of the Laureates has greatly improved our understanding of asset prices and revealed a number of important empirical regularities as well as plausible factors behind these regularities.”
The research of these three Laureates is predicated on empirical analysis of asset prices and their predictability. In the stock market, there is high risk involved with investment in assets. Fama, Hansen, and Shiller set out to find trends that exist in the marketplace. It is notoriously hard to predict market volatility of stocks and bonds in the short run, but the research of the Laureates have found factors that affect the predictability over the long run in the macro economy. With this predictability comes a certain degree of profit.
The research of asset pricing is not new. In an interview with the New York Times, Eugene Fama said that asset pricing depends on efficient-markets theory, a hypothesis he developed in the 1960s. This theory stated that because stock market efficiency causes existing share prices to always reflect all relevant information, it is almost impossible to prosper and “beat the market.” But this theory was highly controversial and disputed by Fama’s fellow Nobel Laureate Robert J. Shiller in the 1980s.
Shiller found that there was some predictability with asset pricing. According to the press release of the Royal Swedish Academy of Sciences, Shiller found that stock prices “fluctuate much more than corporate dividends, and that the ratio of prices to dividends tends to fall when it is high, and to increase when it is low.” This predictability proved true for the stock market, bond market, and other assets. This undercut some of Fama’s research and his efficient-markets theory. In layman’s terms, the idea that past prices were good indicators of future returns was proven incorrect.
In interpreting the data of Fama’s and Shiller’s work, Lars Peter Hansen developed the Generalized Method of Moments (GMM), “a statistical method that is particularly well suited to testing rational theories of asset pricing,” contributing to an interpretation “that connects asset prices to the savings and risk-taking decisions made by rational individuals,” according to the Royal Swedish Academy of Sciences.
Shiller’s work in interpreting the data of asset pricing eventually culminated into the founding of “behavioral finance,” a field that focuses on the mistaken expectations of returns and institutional restrictions, such as borrowing limits, which prevent smart investors from trading against any mispricing in the market. Mistaken expectations can result in price bubbles and crashes. Shiller is famously known for predicting the dotcom bust in the early 2000s, and the housing bubble in 2007.
The Nobel Committee has stated that awarding all three of these Laureates is “contradictory” due to the research being based on discrediting each other’s theories. In his interview with the New York Times, Fama has stated that his and Shiller’s research has come to the conclusion “that there is variation in expected returns, which leads to some predictability in returns. Where we disagree is whether it’s rational or irrational. And there’s nothing in the available evidence that allows one to really settle that in a convincing way. The stuff that both Shiller and I have done has been very illuminating in terms of the behavior of returns. The interpretation of that is open for reasonable disagreement.”
When asked about winning together with Fama in another interview with the New York Times, Shiller responded, “Well, Gene and I have a lot in common, more than you might think. He collects data and he shares it and I use it all the time, and I use many of his theories. Not all of them, of course. But he’s a very good guy.”
Humorously, Shiller added, “It’s like having a good friend who is a devout believer in another religion. You can learn a lot from a friend like that, even if you don’t pray in his church.”
PROFILES
Eugene F. Fama is currently serving as a Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. He is also a fellow of the Econometric Society and the American Academy of Arts and Sciences.
Fama earned his B.A. in Economics from Tufts University in 1960, graduating Magma Cum Laude. He later earned his M.B.A and Ph.D from the University of Chicago Booth School of Business in 1964. He has spent his entire teaching career at the University of Chicago, joining the faculty of the Booth School of Business in 1963.
According to his biography on the University of Chicago Booth School of Business faculty website, Fama is widely recognized as “the father of modern finance.” He is known for his theoretical and empirical research on markets and investment management. His field of study is in financial economics. Fama was also the recipient of three major prizes for research in Finance: “the Deutsche Bank Prize in Financial Economics, 2005, the Morgan Stanley American Finance Association Award for Excellence in Finance, 2007, and the Onassis Prize in Finance, 2009.”
Lars Peter Hansen is currently serving as the David Rockefeller Distinguished Service Professor of Economics, Statistics, and the College at the University of Chicago. He is also a fellow of the National Academy of Sciences and the American Finance Association.
Hansen earned his bachelor’s degree in mathematics and political science from Utah State University in 1974 and a Ph.D. in economics from the University of Minnesota in 1978.
According to his University of Chicago profile, Hansen is most famously known for his research and contribution “to the development of statistical methods designed to explore the interconnections between macroeconomic indicators and assets in financial markets.” His fields of study include econometrics and financial economics. He received the 2010 BBVA Foundation Frontiers of Knowledge Award in the Economics, Finance and Management “for making fundamental contributions to our understanding of how economic actors cope with risky and changing environments.”
Robert J. Shiller is currently serving as a Sterling Professor of Economics at Yale University and is a fellow at the Yale School of Management’s International Center for Finance. He is also an affiliate with Yale University’s Cowles Foundation for Research in Economics.
Shiller earned his B.A. from the University of Michigan in 1967 and his Ph.D. in economics from the Massachusetts Institute of Technology in 1972.
According to his Yale University profile, Shiller is most famously known for his development of the Case-Shiller index, a financial tool for looking at home price indices used by Standard and Poor’s. Shiller’s field of study is in financial economics; he was named by Bloomberg Markets as one of the fifty most influential in global finance in 2011. His latest book, Finance and the Good Society (Princeton University Press, 2012), garnered Shiller the 2012 PROSE Award in Business, Finance & Management from the Association of American Publishers. In addition to winning the Nobel Prize, Shiller also won the Deustsche Bank Prize in Financial Economics in 2009.
Fama, Hansen, and Shiller will be presenting at the Prize Lectures in Economic Sciences. This event will be held on Sunday, December 8, at 1.30 p.m.-3.20 p.m. (CET), at the Aula Magna, Stockholm University. The lectures will be webcast live at Nobelprize.org.
Justin Nalos is a senior at Howard University majoring in English. Howard University is home to the Gamma of the District of Columbia Chapter of Phi Beta Kappa.