BackA Nobel cheer for markets
The 2013 Economics Nobel Prize winners have shed light on some aspects of market economics
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The 2013 Bank of Sweden Prize in Economics, also known as the Economics Nobel Prize, has been awarded to three macroeconomists whose work has gone a long way in clarifying how markets work. Each of the three laureates, Eugene F. Fama, Lars Peter Hansen and Robert Shiller, have shed light on some aspects of market economics.
It was a 1970 paper by Fama that led to what is called the efficient markets hypothesis. Fama showed in mechanistic detail how markets price bits and pieces of information that leads to movements in, for example, stock prices. This paper spawned an entire literature on testing and debating the role of price formation and discovery in diverse markets. Fama showed that in the absence of informational asymmetries, the movement of stock prices is a random walk. What this means is that it is impossible to make sustained profits by, for example, insider trading.
In later years the original Fama paper has attracted notoriety: the recent run of high-profile insider trading cases and the spectacular collapse of global markets in 2008-09 called into question some of the assumptions he made in his original paper. In fact, Nobel Prizes have been awarded for showing informational limits to the efficiency of markets.
The second laureate in the trinity, Hansen, actually made possible much of the empirical testing that lay behind what Fama claimed. Hansen is an econometrician who pioneered a new technique called the generalized method of moments (GMM) that allows better forecasts of prices and other data. Today GMM is a standard, graduate class, econometric technique but it makes possible much of bread and butter macroeconomic forecasting that lies behind growth and price forecasts so common today.
The third laureate, Shiller, is perhaps the most well known of the three. He is not only well-known for the Case-Shiller house pricing index but is also known to have cautioned against “irrational exuberance" that lay behind the stratospheric valuation of house prices and equities both in the US and much of the West.
The bunching together of this diverse set of economists may seem puzzling. Fama is an academically polarizing figure and his papers evoke strong passion. Shiller seems to be the very antithesis of what Fama argued: he showed how certain markets had badly mispriced information or even had systematic barriers that prevented the utilization of relevant information in correcting prices. What links the three is the centrality of markets in our world.
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