BackEconomics Nobel 2013: The underlying thread
It seeks to show that finance is not a completely parasitic activity, or that the markets are not just gambling dens
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The Nobel Prize for economics has been awarded to three economists --- Eugene Fama, Lars Peter Hansen and Robert Shiller. They get it for their empirical analysis of asset prices.
This is the third time that the award has been given to financial economists. Harry Markowitz, Merton Miller and William Sharpe won it in 1990 for their pioneering work in the theory of financial economics. Then Robert Merton and Myron Scholes were given the award in 1997 for research on how to price derivatives, which included the famous Black-Scholes model of option pricing (Fisher Black could not be given the prize because he died in 1995).
The 2013 prize has been given at a time when there continues to be a great amount public suspicion of high finance, five years after the global financial system almost imploded at the end of 2008. The fundamental mispricing of risk in the bubble years has undermined the belief in rational markets.
Fama is best known for his efficient markets theory. He has shown that markets rapidly absorb information. Asset prices reflect all available information which is why it is very difficult to beat the market on a sustained basis, which created the intellectual groundwork for passive index funds.
Shiller has become famous in recent years for warning against a US asset bubble much before it popped. Some of his work has shown how behavioural errors ensure that market participants do not always process information correctly.
Hansen is a less well-known figure. He is an econometrician who has developed tools such as the generalized method of moments (GMM) to test various theories about asset prices, including those by Fama and Shiller.
Fama and Shiller in many ways represent opposite views on the rationality of markets. The Nobel Prize has already been awarded earlier to economists who have studied the implications of asymmetric information (2001) and behavioural quirks of economic agents (2005). The decision to jointly honour Fama and Shiller is similar to the decision to split the 1974 award between the libertarian F.A. Hayek and the social democratic Gunnar Myrdal.
But there is an underlying commonality in the 2013 prize. It honours three brilliant economists who have shown that while the direction of asset prices cannot be predicted in short time frames of a few weeks, it is possible to gauge their direction over three to five years. It in a way seeks to show that finance is not a completely parasitic activity, or that the markets are not just gambling dens.
It is worth noting that Shiller has even written a book that argues that financial markets can help citizens help hedge against risks such as unemployment. The name says it all: Finance and the Good Society.
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