Why These Three Economists Won The Nobel Prize

If you want to know how and why stocks, bonds, homes, and every other financial asset change in price, ask these three.

1. Three financial economists won this year’s economics Nobel Prize: Robert Shiller, Eugene Fama, and Lars Hansen. The Royal Swedish Academy of Sciences said they “have laid the foundation for the current understanding of asset prices.”

Michelle Mcloughlin / Reuters

Jim Young / Reuters

Handout / Reuters

 

The Nobelists, Robert Shiller, Eugene Fama, and Lars Hansen

3. Starting with his dissertation in 1965, Fama wrote a series of papers while at the University of Chicago that eventually formed the “efficient market hypothesis.”

4. Fama’s basic insight was that you could not predict the future price of a stock from what they had done previously or from publicly available information, which was already reflected in the price.

5. Basically, all these charts are worthless. You can’t predict a stock’s price based on its past movements.

7. Fama’s work is the basis for indexed mutual funds, which don’t pick individual stocks but try to track the overall market. Fama says that “active management is a zero-sum game. That’s not hypothesis, that’s arithmetic.”

Although it was controversial when it was first introduced, many personal finance experts and academics swear by this low-fee, passive approach to investing.

8. Funny enough, one of Fama’s teaching assistants in the 1980s was future billioniare hedge fund manager Cliff Asness.

Asness says that he “still feels guilty when trying to beat the market” because of his time working with Fama at the University of Chicago.

9. Robert Shiller, however, is a major critic of the efficient markets approach. Starting in 1981, Shiller pointed out that stock prices were far more volatile than simple models of future returns would suggest.

This paper, published in 1981, is one of the most cited economics papers of all time and helped launch “behavioral finance,” which tries to explain how financial assets move in price in ways that might appear to be irrational.

10. Shiller, a Yale professor, became famous outside the ecnomics community when he spotted the tech bubble in the late 1990s, predicting it would burst. He was right.

11. Shiller even warned Alan Greenspan, in 1996, about “irrational exuberance” in the stock market. Greenspan used the phrase in a speech and Shiller’s own book came out just as the NASDAQ peaked in 2000.

Princeton University Press / Via press.princeton.edu

12. Shiller called another bubble in 2005: This time, it was housing. Home prices had almost doubled in just five years and the market would peak less than two years later.

13. Since the housing bubble collapsed, Shiller and his fellow Nobelist George Akerlof have led the push to get academic economists to consider how big a role emotion — or “animal spirits” — plays in the economy.

Princeton University Press

 

14. Lars Hansen, while a very important figure in analyzing asset prices, did work that is less accessible and easy to explain. Sorry, Lars! If you really want to know, click here.

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