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Nobel in Economics to three Americans trying to unravel 2008 financial crisis

Fama, Hansen and Schiller “laid the foundation for the current understanding of asset prices”

Eugene F. Fama, Robert J. Shiller and Lars Peter Hansen shared the 2013 Nobel Prize in Economic Sciences for at times conflicting research on how financial markets work and assets such as stocks are priced. The three economists, all Americans, “laid the foundation for the current understanding of asset prices,” the Royal Swedish Academy of Sciences, said in Stockholm.

“It relies in part on fluctuations in risk and risk attitudes, and in part on behavioural biases and market frictions.”

Their work spans almost 50 years of research, beginning with the finding by the University of Chicago Fama that it’s difficult to predict price movements in the short run. That conclusion forms the basis for the theory that financial markets are efficient and led to the development of stock-index funds.

Later papers by Shiller and the University of Chicago’s Hansen focused on longer-run price swings and the extent to which they could be explained by such fundamental features as dividend payouts on stocks and the risk appetite of investors. Yale University Shiller, in particular, took issue with the argument that investors are always logical, using the phrase “irrational exuberance” to explain run-ups in asset prices.

The winners represent 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.

The award comes five years after a financial crisis that drove the U.S. and world economies into their deepest recession since the Great Depression.

Fama, 74, has dismissed criticism that the turmoil undercut his thesis that markets are efficient, arguing that it was triggered by developments in the economy, including a fall in house prices and the onset of a recession.

In the mid-1960s, he propounded theories arguing that stock-price movements are unpredictable and follow a “random walk,” making it impossible for any investor, even a professional, to gain an advantage. He also showed in later work that so-called value and small-cap stocks have higher returns than growth stocks, and he rejected the notion that markets often produced bubbles.

“Fama’s research at the end of the 1960s and the beginning of the 1970s showed how incredibly difficult it is to beat the market, and how incredibly difficult it is to predict how share prices will develop in a day’s or a week’s time,” said Peter Englund, professor in banking at the Stockholm School of Economics and secretary of the committee that awards the Nobel Prize in Economic Sciences. “That shows that there is no point for the common person to get involved in share analysis. It’s much better to invest in a broadly composed portfolio of shares.”

Since 1981, Shiller has been at the vanguard of economists chipping away at the theory of efficient markets. His research showed that investors can be irrational and that assets from stocks to housing can develop into bubbles.

“Shiller found that stock prices were bad ‘weathermen,’” said Nobel laureate George Akerlof, an economics professor at the University of California at Berkeley and husband of Janet Yellen, President Barak Obama nominee to be Federal Reserve chairman. “Historically, they have been much more variable than the current value of the dividend streams.

“From this evidence, he concluded that rational models of the stock market, in which stock prices reflect rational expectations of future payouts, are in error. This clever combination of logic, statistics, and data implies that stock markets are, instead, prone to irrational exuberance.”

Born in Detroit in 1946, Shiller earned his Ph.D. in economics from the MIT in 1972. Shiller said the 2008 financial crisis “reflected mistakes and imperfections in our financial system that we are already working on correcting. I think there’s much more to be done. I think it will take decades. But we’ve been through financial crises many times in history and we generally learn from them.”

The study of housing prices has been a long-standing interest of Shiller’s. Dissatisfied with existing data, he and Karl Case created the S&P/Case-Shiller home price indexes. These captured U.S. home prices doubling from 2000 to mid-2006 then plunging 35% amid the worst financial crisis since the Great Depression.

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 the implications of dynamic economic models in which decision makers face uncertain environments. He is perhaps best known as the developer of a statistical technique called the generalized method of moments, which broadens the assumptions that researchers can count on, allowing them to focus on other suppositions and linkages in their work.

“Lars is a true giant in both economics and finance,” Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said in an e-mail. Hansen was Kocherlakota’s Ph.D. adviser at the University of Chicago.

Hansen’s “remarkably general empirical methods free researchers from the need to make a range of empirically implausible statistical assumptions about the data that they are studying,” Kocherlakota added. “By doing so, Lars’s methods allow economists to assess the core economic implications of their models and theories relative to the data of interest.”

Born in Champaign, Illinois, Hansen received his Ph.D. in economics at the University of Minnesota in 1978 and his bachelor’s degree in mathematics and political science from Utah State University.