Why the Nobel Prize matters

 
The announcement of the winners of this years Nobel Prize for economics

The Nobel Prize in Economics has been awarded to three academics who have transformed our understanding of stock and house prices.

The official announcement stated that the prize was awarded to Eugene F Fama, Lars Peter Hansen and Robert J Shiller "for their empirical analysis of asset prices".

Fama and Hansen of the University of Chicago will be less known in popular circles than Yale's Robert Shiller - who is one of the people behind the Case-Shiller US house price index.

Fama's 1970 paper is associated with the "efficient market hypothesis", which says that information is quickly incorporated into stock prices so that markets are "efficient".

This meant it was hard to have an advantage over all of those in the market already, so investors might as well consider buying an index fund that tracked a particular stock market, since any information that anyone might have was already factored into the stock price.

Pioneer

All three of these economists are within the field of what's called behavioural finance. Fama as more of a critic.

This field questions just how rational investors and others are, which radically changed the premise that all actors in the economy are perfectly rational.

A US house with a "for sale" sign The Case-Shiller US house price index is a well-known measure

Sounds strange, I know, but a lot of economic models are written on the basis that everyone is rational. Just take a look at an undergraduate microeconomics textbook sometime.

Of the three, Hansen's contribution is the hardest to explain. He is the pioneer of an econometric method that helps us to improve the understanding of how a variable, say a stock market or housing index, is affected by another, e.g. credit availability.

For those who are truly keen, it's known as the Generalised Method of Moments or GMM.

Hollywood

Finally, Shiller is probably better known because he has not only warned about the US housing bubble, but has written several popular books. His work analyses what determines asset prices and he also created an index that tracked US house prices over a long period of time.

He explained to me that when he started looking at house prices, he was astounded that such a long-term index didn't exist. Thus, the Case-Shiller index was born.

The Nobel Prize carries with it a hefty prize of eight million kronas or about $1.2m. But it's the prestige that matters.

Like a Hollywood film, the award brings greater attention to the work of the recipients.

For many of us seeking to understand how the last financial crisis happened and are worried about the next housing bubble or dotcom boom and bust, their research is certainly worth taking a look at.

 
Linda Yueh Article written by Linda Yueh Linda Yueh Chief business correspondent

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  • rate this
    0

    Comment number 94.

    93. Up2snuff "They should have known (so should our economists) but did not."

    They knew all right. But thought that their tame bribed economists would change reality for them - the liar believing their own lies!

  • rate this
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    Comment number 93.

    re#84
    If Shiller's teachers&other contemporary econs were defective in knowledge of 'bubbles' {& he obviously outran/outshone them} what about our political leaders of 90s&00s. Major&larke, Blair&Brown. They all were born before late 60s/70s commercial prop boom/NWest failure & Thatcher property boom & crash as predicted by Beckman. They should have known (so should our economists) but did not.

  • rate this
    0

    Comment number 92.

    John_from_Hendon @90,91
    "price of money"
    Reminders as ever relevant!

    But, while we're on about the 'idiotic' in policy, and about grasp of the 'fundamental & obvious', a thought perhaps for the context of neglect and recklessness in decision-making? Is it not always material conflict of interest, either in the decision-maker or in those around… those who could have 'spoken-up', but dared not?

  • rate this
    +1

    Comment number 91.

    88 alan

    If the time price of money was astronomic - nobody would borrow, would they? So the converse is also true. Provided there are no other limits. The other limits such as LTV and Income Multiple were universally abandoned. Now can you comprehend why the idiot economists caused the properly bubble. Understand that und ist alles klar!

    Auch über die Kreditgeber denken. Die Bankokratie!

  • rate this
    +1

    Comment number 90.

    88.alan

    You are ludicrously wrong in the case of housing. You seem to lack any common sense comprehension of the price consequences of reducing price of money to a nugatory level on products almost completely financed by debt. You only seem to understand non-debt-linked goods. You must have worked for a bank, or worse, taught the subject!

    However your last two sentences do show some grasp.

 

Comments 5 of 94

 

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