Econintersect: Robert Shiller (Yale University) shared the 2013 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel with two University of Chicago professors, Eugene Fama and Lars Peter Hansen (no relation to Econintersect co-founder and publisher, Steven Hansen). The citation said indicated the three were being recognized for having “laid the foundation for the current understanding of asset prices“.
Video summary follows the Read more >> jump.
The following video gives a brief overview of the work of two of the three award recipients.
The news services contain descriptions of the accomplishments of the winners that Econintersect feels are over-simplifications of their work to the point of being misleading in some cases. In The Financial Times:
Mr Fama, from the University of Chicago, is one of the fathers of the so-called “efficient market hypothesis”. This theory – which underlies his seminal 1965 paper “Random Walks in Stock Market Prices” – formulates that markets are “informationally efficient”, as investors immediately incorporate any new available information in the price of an asset.
The statement of the efficient market hypothesis is the same which has been quoted in textbooks for several decades. However it is not “settled science” but has been rather effectively contested by a number of researchers with well documented studies in the past few years:
- In a 2012 NBER working paper, Roger E.A. Farmer, Carine Nourry and Alain Venditti presented “The Inefficient Market Hypothesis“.
- Nassim Nicolas Taleb wrote a book on problems with the assumptions of efficient markets, “The Black Swan“. Occasional improbable events (improbable under the assumptions of normal distributions made by Fama and others) create events with massive consequences simply because almost everyone is working within the normal distribution assumptions that are catastrophically invalid on occasion of failure.
- Clive Corcoran in his book “Systemic Liquidity Risk and Bipolar Markets” provided detailed data of rapidly changing correlations that disrupt the normal distribution assumptions of The Efficient Market Hypothesis over periods of time from a few months to a few years. (Clive Corcoran is a Global Economic Intersection contributor.)
Editorial comment: The work of the three economists recognized this year is seminal and Econintersect does not denigrate the worthiness of all three. However, the popular characterizations of some of the work, even in text book statements, ranges outside of the practical applications that are warranted for the work and probably outside of interpretations that the three economists would want to recommend.
When a “hundred-year event” occurs it can totally destroy a program that is based on distribution analysis based on 3, 5, 10, 20 or even more years of data. Such “black swan events” create what Taleb calls a “fat tail” occurrence which is totally outside the predictions of historical data. Corcoran has shown how such events have repeatedly occurred in specific markets over recent years. There are big Black Swans that are represented by entire financial market meltdowns and a myriad of smaller black swans that can occur in specialized narrower markets involving anything including currencies, commodities and/or stocks.
Of course market manipulations such as are alleged for FX markets, interest rate benchmarks and other markets are also outside of the assumptions of the Efficient Market Hypothesis. When gross asymmetries of information exist markets cannot be efficient by definition. (Read again the definition in the excerpt from the Financial Times, above.)
Click here for John Authers’ interview of Nassim Nicholas Taleb for the Financial Times.
Sources:
- Trendspotting in asset markets (Press Release, The Royal Swedish Academy of Sciences, 14 October 2013)
- Fama, Hansen and Shiller win Nobel Prize for economics (Ferdinando Giugliano and John Aglionby, Financial Times, 14 October 2013)
- The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World (Roger E.A. Farmer, Carine Nourry and Alain Venditti, NBER Working Paper No. 18647, December 2012)
- The Black Swan (Nassim Nicholas Taleb, Amazon.com)
- Systemic Liquidity Risk and Bipolar Markets (Clive Corcoran, Wiley, 2013)
