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Latest Nobel Prize Reflects How Economics Works -- and What Economists Don't Know

Newspaper article

Latest Nobel Prize Reflects How Economics Works -- and What Economists Don't Know

Article excerpt

"The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2013 was awarded jointly to Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller 'for their empirical analysis of asset prices.'"

Boy, could you be any more boring than that? The Nobel committee probably would have described the Reformation as a dispute between the Vatican and a monk.

Here is my summary of the prize, awarded last week: One laureate thinks financial markets work well, another thinks not, and the third developed statistical techniques to test the competing hypotheses and concluded they are both partially true. This leaves a lot of space for spirited disputes about the nature of financial markets and for more research on this important topic.

Fama posited what has come to be called the efficient markets hypothesis. According to Fama: "An efficient market is a market that is efficient in processing information. The prices of securities at any time are based on correct evaluation of all information available at that time. In an efficient capital market, prices fully reflect available information." Financial markets work well.

Shiller is the leading developer the field known as behavioral finance. As he told the Washington Post: "When I look around I see a lot of foolishness, and I can't believe it's not important economically." In particular, Shiller argues that financial markets don't work well and are prone to bubbles such as the stock market boom and bust of the late 1990s and the housing market of the 2000s. (Shiller, along with Karl Case of Wellseley College, developed the home price indices that bear his name.)

Hansen, who earned his Ph.D at the University of Minnesota, created statistical techniques that allowed economists to test the Efficient Markets Hypothesis against the data. The method, called Generalized Method of Moments Estimation, quickly became a standard tool in the financial economist's toolbox. …

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