This year three economists split the Nobel Prize for economics. They were recognized for their contributions to the measuring of asset pricing. Although these economists did not work directly together, their research, sometimes even conflicting, has been instrumental to our understanding of financial markets today.
Eugene Fama
Eugene Fama, a professor of finance at the University of Chicago, improved theory essential to the Efficient Market Hypothesis. Fellow academics sometimes refer to him as the “father of modern finance” and the “father of the Efficient Market Hypothesis.” He studies risk and return and implications of portfolio management. While still in graduate school at the University of Chicago, Fama began researching and publishing findings on Random-Walk theory. This theory was not new, but he contributed to it and added statistical analysis. His findings said that stocks often respond unpredictably to news in the short-term, but analysis can find trends in the long-term, suggesting that it is nearly impossible to beat the market. He believes stocks are priced based on all available information.
His research led to the creation of stock-index funds. These funds are a type of mutual fund made up of a portfolio that attempts to track or match an index. The benefits of this strategy are a broad coverage and low transaction and operating costs. The broad coverage is a diversification method that lowers risk. The low costs come from the idea of a “passive investment,” where the stock-index is established then left alone for the most part. Top investors such as Warren Buffett, Charles Schwab, Jack Bogle, Nobel-winning economists, and large U.S. pension funds invest in these index funds. Although slow to catch on, index mutual funds made up about 15% of the assets in U.S. stock and bond funds as of 2012.
Robert Shiller:
Robert Shiller is a Sterling Professor of Economics at Yale University. He completed his B.A. at the University of Michigan and he completed his Ph.D. from MIT in 1972.
Unlike Fama, he is not a supporter of the efficient market theory. Instead, Shiller asserts that markets are driven more so driven by human psychology or the present human appetite for risk. He believes that market trends that are deemed “unpredictable” by the traditional economic theory are caused by “quirks” in human psychology.
Dr. Shiller is known also known for the Case-Shiller Index. This index is the leading measure of residential real estate prices in the U.S.
Lars Peter Hansen:
Dr. Hansen is a David Rockefeller Distinguished Service Professor at the University of Chicago. He completed his undergraduate coursework in Political Science and Math at Utah State University (1974) and completed his Ph.D. in Economics at the University of Minnesota in 1978.
Dr. Hansen is widely known for being the lead developer of the Generalized Method of Moments (GMM) which is a generic method for estimating parameters in statistical models. The GMM is used in econometrics to broaden assumptions that researchers deem reliable.
The GMM has been used to analysis data and asset prices thereby, allowing for economists to better test theories on what drives the market. For example, the GMM was used to build on Shiller’s work by helping to establish human behavior as the cause of volatility in prices. In essence, This more strongly established the idea of that mispricing was correlated to people’s desire for risk.
All in all, in December, these three American economists will be awarded the $1.2 Million on behalf of the Nobel committee. Congratulations to the three of them!
By Zacher Bayonne and Tom McCartin
http://www.chicagobooth.edu/faculty/directory/f/eugene-f-fama
http://www.bloomberg.com/news/2013-10-14/fama-hansen-shiller-share-nobel-economics-prize-academy-says.html
http://www.bloomberg.com/news/2013-10-14/fama-s-nobel-work-shows-active-managers-fated-to-lose.html
http://www.investopedia.com/terms/i/indexfund.asp
http://www.marketwatch.com/story/13-reasons-index-mutual-funds-and-etfs-rule-2013-07-24
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