Advocate — and critic — of efficient markets share Nobel

THREE American scientists won this year’s economics Nobel prize yesterday for research that has improved the forecasting of long-term asset prices, a hot topic since the collapse of the US housing market bubble prompted a global financial meltdown.

The prize recognises nearly 50 years of research, which started with the conclusion back in the 1960s that short-run movements in stock prices were difficult to predict. It culminated in work on how longer-run price swings could be explained by factors such as dividend payouts and investors’ risk appetite.

Eugene Fama, the 74-year-old “father of modern finance”, Robert Shiller and Lars Peter Hansen had together “laid the foundation for the current understanding of asset prices”, the Royal Swedish Academy of Sciences, which selects the winner, said.

Robert Solow, winner of the Nobel economics prize in 1987 and professor emeritus at the Massachusetts Institute of Technology, said the award winners were a “very interesting collection because Fama is the founder of the efficient market theory and Shiller at least is one of the critics of it”.

He said it showed the academy was “interested in all those that had contributed to the modern theory of finance at both ends of the spectrum”.

In the mid-1960s Prof Fama put forth theories that argued that stock prices are unpredictable and follow a “random walk”, making it impossible for any investor, even a professional, to gain an advantage. He also showed in later work

that so-called value and small-cap stocks have higher returns than growth stocks, and rejected the notion that markets often produce bubbles.

Peter Englund, professor of banking at the Stockholm School of Economics and secretary of the committee that awards the prize, said Prof Fama’s research had showed how hard it was to beat the market or to predict share price movements.

Prof Shiller, of Yale University, showed in the 1980s that it was easier to predict prices over the long term after finding that stock prices fluctuated more than changes in a firm’s dividends would suggest.

His research showed episodes when assets were overvalued and warned of bubbles, such as technology shares in the late 1990s and, more recently, in US house prices.

He is at the vanguard of economists chipping away at the theory of efficient markets as, he argues, investors can be irrational and assets can develop into bubbles.

The main theme of Prof Hansen’s research has been to devise and apply econometric methods which work within the frameworks of the economic models under investigation.