US trio Lars Peter Hansen, Eugene Fama and Robert Shiller wins Nobel Economics Prize
US trio Lars Peter Hansen, Eugene Fama and Robert Shiller won the Nobel Economic Prize this week for groundbreaking work on spotting trends in asset markets.
The three have laid the foundation for the current understanding of asset prices. It relies in part on fluctuations in risk and risk attitudes, and in part on behavioural biases and market frictions.
The three have laid the foundation for the current understanding of asset prices. It relies in part on fluctuations in risk and risk attitudes, and in part on behavioural biases and market frictions.
Fama and Hansen are both professors at the University Of Chicago, while Shiller is a professor at Yale University in Connecticut.
The economics prize is the only Nobel not originally included in the last will and testament of the prizes' creator, Swedish scientist and philanthropist Alfred Nobel.
It was established in 1968 by the Swedish central bank to celebrate its tri-centenary, and first awarded in 1969. The other prizes have been awarded since 1901.
Americans have dominated the list of economics laureates, with 17 out of 20 laureates coming from the US in the past 10 years.
Last year, US scholars Alvin Roth and Lloyd Shapley won for their work on the functioning of markets and how best to match supply and demand.
The economics prize winds up this year's Nobel season, marked by awards in physics to the fathers of the Higgs Bosson, the literature prize to Canadian short story author Alice Munroe, and the peace prize to the UN-backed Organisation for the Prohibition of Chemicals Weapons.
In praise of empiricism: a Nobel prize for everyday economics
Fama, Shiller and Hansen are worthy winners for focusing on the messy reality of market behaviour, rather than abstract theories
Eugene Fama: The man who won the Nobel memorial award in economics, discovered years ago that stockpicking was a fool's game; you can't really beat the market. An entire industry of index funds exists because of Fama's research.
His two co-winners are also men who care what happens in the real world. Economics has a reputation as wonky, nerdy discipline that loves theories that are pure and distant from humanity, like cottony clouds, and hates to get its hands dirty with real-world concerns. This year's Nobel prize in economics is finally, a victory for the study of human nature.
The three winners this year – Eugene Fama, Robert Shiller and Peter Lars Hansen – study stock and bond markets and the abnormal psychology of bubbles, and why we fail to pick stocks. They are interested in numbers, yes, but mostly, they are interested in how real people behave under financial stress. Fama said :
Finance drew me in because it's so fundamental to human activity. It follows precise mathematical relations but there's an element of imprecision that reflects human nature.One winner, Robert Shiller, created an influential housing index. He is known for spotting bubbles early. The other winner, Lars Peter Hansen, found new ways of thinking about stocks and risk. And Fama showed that investors can't really beat the market in the short term; when you invest in an S&P 500 index fund, you're making use of his work, just as I did. A colleague at the University of Chicago said during the ceremony that Fama had had "a phenomenal impact on the practical world and people's lives."
Fama, Hansen and Shiller have often disagreed about the specifics of how the real world works. Fama has said he doesn't believe in bubbles; Shiller, who wrote the book Irrational Exuberance, spots them. But what unites them is that these are three men who aren't looking for the perfect world. They're happy to figure out a world in which orderly spreadsheets of numbers are overwhelmed by the venal, panicky, chaotic tendencies of humanity in a crisis.
This is the kind of economics we need more of: the kind that speaks to us. With the financial crisis and recession, economics are part of our daily lives. The unemployment rate, housing sales, mortgage lending rates … we all live with these numbers weekly, in our communities and in our wallets. Those numbers are part of the study of economics. They also describe the world we live in.
A lot of economics, however, depends on unreliable numbers. It's not about the cold, hard truth. When we talk about the unemployment rate, for instance, we're not really talking about how many people are unemployed in the country. It's an educated guess, based on a survey of companies and a survey of people. It's also often wrong the first time, and needs to be revised multiple times before it's right. The same goes for a range of other economic data, like GDP.
That's why it was so important that the Nobel committee praised Shiller, Fama and Hansen for their empirical work. Empirical means they are trying to get a numerical sense of the real world. They are working on ways to measure our economic behavior more accurately, and to help us understand ourselves better in the process.
The very premise of most economic theory is that we all
exist in a perfect world where people make rational choices, a world of
neat levers and switches. It's orderly, but it's not exactly accurate.
This year's three winners show us that economics does not exist in a
perfect world, a soundproof chamber, but instead, in the irrational,
unpredictable scrum of humanity.
Ref: ET, The Guardian & Google.
Trendspotting in asset markets:
ReplyDeleteThere is no way to predict the price of stocks and bonds over the next few days or weeks. But it is quite possible to foresee the broad course of these prices over longer periods, such as the next three to five years. These findings, which might seem both surprising and contradictory, were made and analyzed by this year’s Laureates, Eugene Fama, Lars Peter Hansen and Robert Shiller.
Beginning in the 1960s, Eugene Fama and several collaborators demonstrated that stock prices are extremely difficult to predict in the short run, and that new information is very quickly incorporated into prices. These findings not only had a profound impact on subsequent research but also changed market practice. The emergence of so-called index funds in stock markets all over the world is a prominent example.
If prices are nearly impossible to predict over days or weeks, then shouldn’t they be even harder to predict over several years? The answer is no, as Robert Shiller discovered in the early 1980s. He 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 pattern holds not only for stocks, but also for bonds and other assets.
One approach interprets these findings in terms of the response by rational investors to uncertainty in prices. High future returns are then viewed as compensation for holding risky assets during unusually risky times. Lars Peter Hansen developed a statistical method that is particularly well suited to testing rational theories of asset pricing. Using this method, Hansen and other researchers have found that modifications of these theories go a long way toward explaining asset prices.
Another approach focuses on departures from rational investor behavior. So-called behavioral finance takes into account institutional restrictions, such as borrowing limits, which prevent smart investors from trading against any mispricing in the market.
The Laureates have laid the foundation for the current understanding of asset prices. It relies in part on fluctuations in risk and risk attitudes, and in part on behavioral biases and market frictions.
SWAMINOMICS: Nobel Prize winners say markets are irrational, yet efficient
ReplyDeleteBy SWAMINATHAN S ANKLESARIA AIYAR (TOI)
Are stock markets irrational, driven by greed and fear, subject to euphoria and panic? Or are they highly efficient indicators of intrinsic value? Both, says the Nobel Prize Comittee for Economics, with no sense of contradiction.
It has just awarded the prize jointly to economists with opposing views. Robert Shiller is famous for two versions of his book ‘Irrational Exuberance’. The first version appeared in 2000 at the height of the dotcom boom, and correctly predicted that this was a bubble about to burst. The second version came in 2005 just as the housing market was skyrocketing, and predicted (again correctly) that this too was a bubble likely to burst resoundingly.
This confirmed Shiller’s status as a behavioural economist. Such economists laugh at the notion that human beings are rational economic actors, as portrayed in textbooks. No, say behaviourists, humans are driven by fads, prejudices, manias, and irrational bouts of optimism and pessimism.
Yet Shiller is going to share the Nobel Prize with Eugene Fama, famous for his “efficient markets hypothesis.” This states that markets are like computers processing information from millions of sources on millions of economic actors, and hence produce more efficient long-run valuations than the most talented genius.
SWAMINOMICS: Nobel Prize winners say markets are irrational, yet efficient
ReplyDeleteBy SWAMINATHAN S ANKLESARIA AIYAR (TOI)..Contnd...
Fama’s market behaviour is fundamentally random, so future trends cannot be predicted by even the cleverest investors. He implies that choosing stocks by throwing darts at a stock market chart can beat the recommendations of top experts. This has been verified by some, though not all, dartthrowing contests.
Corollary: ordinary investors must not pay high fees to experts to pick winners. Instead they should invest passively in a group of shares (like the 30 shares constituting the Bombay Sensex or Dow Jones Industrial Average), and ride these bandwagons without paying any fees. This has led to the spectacularly successful emergence of Index-traded funds (like those run by Vanguard in the US). Such funds are indexed to share groups like the Sensex or the Banks Nifty. Rather than try to pick individual winners in say the auto, pharma or realty sectors, index funds invest passively in a group of auto, pharma or realty companies. This has proved successful and popular.
Two groups criticize the efficient markets hypothesis: big investment gurus and, paradoxically, leftists viewing financial markets as instruments of the devil. Investment gurus like Warren Buffett in the US or Rakesh Jhunjhunwala in India claim to have beaten the market average handsomely, thus disproving the efficient markets hypothesis. Not so says Fama: in any large collection of investors there will always be some who perform above average and some below average — this is a matter of statistical chance, not skill. Moreover, investment gurus have so many contacts that they may have insider information enabling them to beat the market by unfair means.
As for Shiller’s successful predictions, Fama says capitalism is driven by booms and busts. To predict at the height of a boom (like Shiller) that a bust will follow is banality, not genius. It is as unremarkable to predict during every bust that a boom will follow.
After the 2008 global financial crisis, the new conventional wisdom is that governments need macro prudential policies to check future financial crises, and that finance should be more strictly regulated than ever before. However, the counter is that the financial crisis occurred even though the financial sector was already the most regulated (with 12,000 regulators in the US alone). Governments had encouraged reckless lending by guaranteeing large banks and investment banks against failure, and by creating governmentbacked underwriters like Fannie Mae who shouldered any burdens caused by mass default.
Perhaps the Nobel Prize Committee is right in implying that markets can be both irrational and efficient at the same time. Since humans are irrational, they will always create markets that have booms and busts, marked by irrational optimism and pessimism. An efficient markets defined by Fama and his followers is not one that produces steady growth without booms, busts or crises. It is efficient only in the limited sense that, whether the markets are calm or irrational, they represent the processed information of millions of actions of millions of actors, and this is inherently more efficient than the efforts of any individual investor.
The argument is analogous to the one against communism or dictatorship. Communists believed that the great and good politburo, motivated entirely by the public interest and not profit, would run the economy better than the chaos, irrationality and imperfections of the capitalist market. Yet the market, with all its flaws and irrationality, proved infinitely more efficient.
Fama holds that this is true of financial markets too. This is compatible with Shiller’s analysis. Markets can be both irrational and efficient.