A Nobel Prize for the Empirical Analysis of Asset Prices

Abstract

The 2013 Nobel Memorial Prize in Economics was awarded to Eugene Fama, Robert Shiller, and Lars Peter Hansen for their empirical analysis of asset prices. The paper reviews critically the work of the three economists and highlights the differing conclusions that the three researchers reached on the relatively narrow question of the rationality of individual investors. The paper argues that there is a time inconsistency in the idea that markets reveal information about the future and concludes that, despite the sophistication of their statistical analysis, the laureates have been unable to demonstrate how a sophisticated financial economy can produce their empirical results.

Notes

¹The book won the 2000 Commonfund Prize for Best Contribution to Endowment Management Research (YaleNews, 2013).

²In 2005, The New York Times reported that Shiller, who had bought himself a vacation home in 2002, issued yet again warnings of a housing bubble (Leonhardt, 2005).

³In his analysis of finance and social welfare, Shiller accurately describes the predicament of the insecure middle class in which households possess assets but are subject to fluctuating financial circumstances and income. However, that analysis does not even begin to consider the nature of poverty and deprivation in the US or elsewhere. A narrative in which fluctuating fortunes are the result of household decisions misses out completely on corporate finance, in particular the finance of corporations that lies at the root of business cycles in modern capitalism.

⁴The Sharpe ratio is a way of estimating risk-adjusted returns from a portfolio, by subtracting the risk-free rate of return from the portfolio return and dividing the result by the standard deviation of the portfolio return.

⁵Mark Twain's remark, ‘I love science. One receives such a wholesome return of conjecture from such a modest investment of fact’ was the motto for the doctoral thesis of Hyman P. Minsky.

⁶There is a similar time inconsistency in the New Consensus notion that the economy (inflation, economic activity, the output gap) can be regulated by the short-term interest rate set by the central bank. If the central bank is pursuing active monetary policy, then the one thing that is certain about the current rate of interest is that it is ephemeral and should therefore be discounted.