Seeing through bubbles

Economics Nobel focuses attention on asset pricing, which gained importance after the 2008 crisis

The 2013 Sveriges Riksbank prize in economic sciences in memory of Alfred Nobel or the fake Nobel, as non-economists like to call it was awarded yesterday to Eugene F. Fama and Lars Peter Hansen of the University of Chicago, and Robert J. Shiller of Yale University for their empirical analysis of asset prices. The committee's picks reflect the continued preoccupation with the global financial crisis of 2008, when the discipline was caught embarrassingly off-guard in its broad failure to anticipate or even warn of the housing and credit bubbles. Fama, Hansen and Shiller's work on asset pricing and financial market theory assumed heightened importance in the aftermath, especially as before 2007, macroeconomic models did not even explicitly include the financial sector.

Fama is widely regarded as the father of modern finance. That stock market prices are unpredictable in the near term the efficient market hypothesis is a keystone of finance, and was one of his earliest contributions to economics. This is based on the belief that all available information is reflected in market prices, which only change to incorporate previously unknown information. Shiller whose prescient 2000 book, Irrational Exuberance, predicted the US housing and stock market bubble was able to establish a predictable pattern in asset returns in the long run. Hansen's econometric formulations were particularly conducive to analysing asset price data.

Though these economists have shaped our understanding of modern finance, spawning hundreds of papers and the substream of behavioural finance, their theories come from different places. As such, the award is an attempt to unify competing schools of thought on how markets sort out the prices of financial assets, an issue with great policy resonance.

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