Fama, Shiller, Hansen bag Nobel for asset price forecasts

In their more than 50 years of research, the three laureates have built knowledge, and exposed holes in the understanding of how asset prices move

Eugene F Fama, Robert J Shiller and Lars Peter Hansen of the US shared the 2013 Nobel Prize in Economic Sciences for their work on creating a deeper knowledge of how market prices move.

"The laureates have laid the foundation for the current understanding of asset prices," the Royal Swedish Academy of Sciences, which selects the winner, said in Stockholm on Monday. "It relies in part on fluctuations in risk and risk attitudes, and in part on behavioural biases and market frictions."

Spanning almost 50 years of research, the three laureates have built knowledge, and exposed holes in our understanding, of how asset prices move, spurring the creation of index funds and also helping predict the US housing market crash last decade. They have shown it's difficult to predict price movements in the short run and easier in the long run and devised statistical methods of testing rational theories of asset pricing.

Fama, 74, known among economists as the "father of modern finance," is a professor at the University of Chicago. In the mid-1960s, he propounded theories that argued stock-price movements were unpredictable and followed a "random walk", making it impossible for an investor, even a professional, to gain an advantage. He also showed in later work that so-called value and small-cap stocks had higher returns than growth stocks, and he rejected the notion that markets often produced bubbles.

Interesting collection
The Nobel committee's decision this year marks a "very interesting collection because Fama is the founder of the efficient market theory and Shiller (at least) is one of the critics of it," said Robert Solow, winner of the Nobel economics prize in 1987 and professor emeritus at the Massachusetts Institute of Technology in Cambridge. "You can understand why they wanted a prize in finance. It's an odd action. It was just an indication that what they were interested in was all those that had contributed to the modern theory of finance at both ends of spectrum."

Fama's work "transformed" Wall Street by promoting the popularity of index funds as investors questioned the value of paying for active portfolio management, Douglas Clement, an official at the Federal Reserve Bank of Minneapolis, wrote in December 2007. "Few economists have had a greater influence on financial theory and practice," he said.

Housing index
The study of housing prices has been a long-standing interest to Yale University's professor Shiller. Dissatisfied with the existing data, he created the S&P/Case-Shiller home price indices, along with Karl Case.

Their index captured US home prices doubling from 2000 to mid-2006 and then plunging 35 per cent amid the worst financial crisis since the Great Depression.

When he learnt he'd won this year's prize, Shiller's reaction was one of "disbelief", he said via telephone at a press conference in Stockholm. "I did not expect it."

Shiller demonstrated in the 1980s that it's easier to predict prices over the long term after finding that stock prices fluctuate more than changes in a company's dividends would suggest. The same relation held for bonds, he found.

Efficient markets
Shiller, born in Detroit in 1946, has been at the vanguard of economists chipping away at the theory of efficient markets, which argued that markets price in all available information and that investors can't beat the market. His research showed investors could be irrational and that assets from stocks to housing could develop into bubbles.

Shiller earned his PhD in economics from the Massachusetts Institute of Technology in 1972. In 1981 he released a broadside against the theory of efficient markets with a paper in the American Economic Review that showed stock prices were far too volatile to reflect the future stream of earnings from the asset. The paper was titled 'Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?'

In 2011, at the journal's centennial, it declared his work one of the 20 most important papers ever published, alongside papers from other Nobel laureates like Milton Friedman, Joseph Stiglitz, Friedrich Hayek and Paul Krugman.

Milton Friedman
Hansen, 60, is one of the co-founders of the Becker Friedman Institute at the University of Chicago, which builds on the legacy of Milton Friedman.

His work explores formal implications of dynamic economic models in which decision makers face uncertain environments. The main theme of his research has been to devise and apply econometric methods that are consistent with the probabilistic framework of the economic models under investigation. His work has implications for consumption, savings investment, and asset pricing.

The Nobel economics prize has in the past helped laureates achieve recognition for their theories outside academic circles, often bringing them closer to policy making. Past winners include Amartya Sen, James Tobin, Paul Krugman.

Last year's prize was awarded to US economists Alvin E Roth and Lloyd S Shapley for their exploration of how to make markets work more efficiently by better matching supply with demand. In 2009, Elinor Ostrom became the first woman to win when she received the prize together with Oliver Williamson for investigating the limits of markets and how organisations worked.