The 2013 Nobel Laureates In Short

The 2013 Nobel Laureates are Eugene Fama, Robert Shiller and Lars Peter Hansen. They were awarded “…for their empirical analysis of asset prices.” Obviously some works are left out – I kept each under 200 words.

Eugene Fama – developed early theories of efficient markets, went on to criticise his own theories, suggested that we cannot separate the joint-hypotheses of efficient markets and pricing mechanisms. For more info: Wikipedia and Homepage. Also read this blog by John Cochrane.

In the early 1960s Eugene Fama set the foundations for efficient markets theory. In the most basic sense, this suggested that all public information on stock markets does not allow the exploitation for excess returns; the market always wins. Significantly, once Fama developed the Efficient Market Hypothesis (EMH), he went on to criticise his own work. That is, in later papers, most notably with French (1992, 1993), he suggested that if you look hard enough, returns excess returns can be found. Further, in 1970 he developed the ‘Joint-Hypothesis Problem’. This suggested that the idea of market efficiency and equilibrium in price-setting cannot be separated. That is, you cannot reject market efficiency without an accompanying rejection of the price-setting mechanism. This is because, as long as and alpha exists, we do not know whether this is because of a mis-priced asset or an inefficient market. In his 1970 review article Fama made a strong case for efficient markets. This is the underlying basis of Index Funds.

Robert Shiller – criticised efficient markets, suggested more markets as the solution to markets, and predicted the US Housing Bubble/Internet Stock Bubble. For more info: Wikipedia and Homepage

Robert Shiller developed significant criticisms of efficient markets (the ones that Fama developed), and is the only behavioural economist of the trio. He gained particular attention for his predictions of the US Housing Bubble[1] and of the Internet Stock Market Bubble in 2000[2]. In a famous 1981 piece, Shiller developed the ‘variance bound test’ relating to stock prices. This scrutinized the rationality of stock prices, challenging the EMH. The basic idea was that because the forecast of stock prices (the dividends) hardly vary, while the actual stock prices vary a great deal, investors are irrational. This makes future stock prices movements easier to predict. In 1991, with Campbell, Shiller determined that this variance bound test was also violated with regard to interest rates. This can suggest that markets overreact to new information – this is irrational.  Shiller, Fischer and Friedman (1984) began the coupling of psychology and economics. This proved a crucial step in the development of behavioral economics. Shiller is also famous for developing the Case-Shiller Home Price Indices, and the suggestion of correcting markets by introducing more markets[3].

Lars Peter Hansen – developed the Generalized Method of Moments (GMM) which can be powerful in predicting asset prices (and other complex macro models), provides the method through which we can test Fama and shiller, and has significant work on the link between financial and real sectors of the economy. For more info: Wikipedia and Homepage

Hansen is the odd fit within the trio. Compared to the others, his work revolves around a more macroeconomic, econometric, technical method. His most famous work was in developing the Generalized Method of Moments (GMM) econometric method[4]. This has proved to be significant in application over a range of macroeconomic models, including finance asset pricing models (this is his connection). While the GMM method is technical, the benefits are easy to explain. Unlike MLE, the application of GMM doesn’t require complete knowledge of the distribution of data. In models where there are more moment conditions than parameters, GMM provides a more straightforward (and often more powerful) method to test the specification of the model. The basic idea is to more highly weight the conditions we have better information regarding. In this way, Hansen provides the method through which we can test Fama and Shiller. More info on GMM here, here and here.  Hansen has also produced significant work on the link between financial and real sectors of the economy.

For some other relevant pieces on these topics see:

[1] Case, K. E. and Shiller, R. J. (2003) – ‘Is There a Bubble in the Housing Market: An Analysis’

[2] Shiller, R. (2000), ‘Irrational Exuberance

[3] Shiller suggested that a GDP market could allow investors to buy and sell shares in GDP – allowing the creation of many insurance and hedging products. He suggested that one of the issues with the housing bubble was that there was no way to short the housing market to moderate the bubble.

[4] Hansen, L. P. (1982) – ‘Large Sample Properties of Generalized Method of Moments Estimators’

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