Ordinary investors don’t stand much chance of beating the market. It moves way too fast and efficiently. Or it behaves in ways that make no sense at all.
Three Americans won the Nobel prize in economics Monday for their sometimes-contradictory insights into the complexities of investing.
Eugene Fama and Lars Peter Hansen of the University of Chicago and Robert Shiller of Yale University were honoured for shedding light on the forces that move stock, bond and home prices — findings that have transformed how people invest.
Fama’s research revealed the efficiency of financial markets: They absorb information so fast that individual investors can’t outperform the markets as a whole. His work helped popularize index funds, which reflect an entire market of assets, such as the Standard & Poor’s 500 stock index.
“Fama’s work was incredibly fundamental in the ’60s and ’70s,” said David Warsh, who follows economists at his Economic Principals blog. “It led to enormous practical change in terms of people not buying particular stocks but buying index funds.”
Shiller’s research examined asset prices from a contrasting angle. He showed that in the long run, stock and bond markets can behave irrationally, reaching prices that are out of whack with economic fundamentals.
Shiller, 67, predicted the dot-com crash of the early 2000s and the implosion of home prices in 2007. He has also been a pioneer in the field of behavioural economics, or how human emotions, biases and preferences can collectively influence financial markets.
Using mathematical tools like the well-known Case-Shiller index of home prices, Shiller has expanded the available information on asset prices.
Meb Faber, chief investment officer at Cambria Investment Management, said his firm uses a model developed by Shiller to seek stock bargains around the world.
Hansen has focused on statistical models, creating ways to test competing theories of why asset prices move as they do.
Fama and Shiller “provide the ends of the spectrum” between those who believe financial markets are efficient and those who think them deeply flawed, with Hansen “in the middle doing the math,” said Allen Sanderson, a University of Chicago lecturer in economics.
The three economists share the $1.2 million prize, the last of this year’s Nobels to be announced.
“Their methods have shaped subsequent research in the field, and their findings have been highly influential both academically and practically,” the Royal Swedish Academy of Sciences said in Stockholm.
Fama, 74, and Hansen, 60, became the 11th and 12th professors from the University of Chicago to win a Nobel in economics, the most for any university. Harvard is second, with six laureates.
Hansen said he received the phone call from Sweden while on his way to the gym Monday morning. He said he was “still working on taking a deep breath.”
Fama was preparing to teach his first class as a Nobel laureate Monday. Asked whether his students would get a break, he said: “We’ll see, but they’re going to get an exam tomorrow, anyway. They paid their money; they’re going to get the full pill.”
The Nobel prizes in medicine, chemistry, physics, literature and peace were created by Swedish industrialist Alfred Nobel in 1895. Sweden’s central bank added the economics prize in 1968 as a memorial to Nobel.
Americans have dominated the Nobel in economics in recent years. The last time there was no American among the winners was 1999.
Collectively, Fama, Shiller and Hansen didn’t create a simple, unified theory of how financial markets work. Rather, they worked like “blind men feeling an elephant” — each finding a bit of the truth in a vast and complicated field, Sanderson said.
Fama’s work drew criticism after the financial crisis of 2007-09 seemed to prove that financial markets were anything but efficient. Housing prices, after all, had scaled great heights and then crashed.
But David Backus, an economist at New York University, said “people completely misunderstand” what Fama was arguing.
“He said that information out there will be reflected in (asset) prices. That is completely different from saying financial markets work well,” Backus said.
It was striking that Monday’s prize went to both Fama and Shiller, who emphasizes not market efficiency but market failures and inefficiencies.
“The committee covered all the bases,” George Mason University economist Tyler Cowen quipped on his blog, Marginal Revolution.
Still, the University of Chicago’s Sanderson said Fama, with his belief that investors can’t outsmart the market, and Shiller, with his study of financial excess, would probably offer similar investment advice.
“Both would probably say: ‘Don’t spend a whole lot of time listening to your stockbroker.'”
Wiseman reported from Washington, Ritter from Stockholm. Associated Press writers Malin Rising in Stockholm, Stephen Singer in Hartford, Conn., and Don Babwin and Ashley Heher in Chicago, contributed to this report.