When world-renowned academic Robert Shiller gave the keynote speech at the inaugural portfolio institutional awards in 2012, it was hard to imagine him ever topping the achievement. So it was with surprise and delight that we heard this week he had been awarded the Nobel memorial Prize for economics.
Alongside Shiller, the Swedish Riksbank also awarded the prize to fellow academics Eugene Fama and Lars Peter Hansen for their work on how the value of assets varies over time.
The decision to award the scholars is perhaps more relevant to investors than in any other year, with two of the three winners – Shiller and Fama – directly recommending methods of playing the markets. Their conclusions, however, could not be more different. Fama is regarded as the father of efficient market theory, claiming that stock picks are extremely hard to predict and it is effectively a waste of time trying to beat the index.
Shiller, meanwhile, is regarded as the father of the inefficient market theory, which argues that any explanation of investors’ behaviour cannot be fully based on rationality and must acknowledge the role played by psychology. In the 1980s, he showed that stock prices tend to fluctuate more than corporate dividends. This should not happen if investors were fully rational, since stock prices forecast future dividends.
The joint-award came as a shock to many, with the general response neatly summed up by Paul De Grauwe, professor at the London School of Economics. “Nobel Prize for Fama who led millions to believe financial markets are efficient and for Shiller who showed opposite. What a contradiction,” he tweeted.
The obvious question is, if Fama’s and Shiller’s views are so diametrically opposed – and given the pounding the efficient market theory has received over the past few years – why award both? The Nobel committee clearly sees the value in both contributions, writing in its announcement: “The Laureates have laid the foundation for the current understanding of asset prices. It relies in part on fluctuations in risk and risk attitudes, and in part on behavioural biases and market frictions.”
And once you look beyond the headline differences between the two theories, you can begin to see their point: both men have contributed to our understanding of the same thing. The lines of research from Fama and Shiller are different, but they’re both groundbreaking empirical investigations of the same basic issue — what happens with financial market prices and why.
So perhaps this year’s joint award can remind us that nothing is black and white in economics: there is no right or wrong; the truth lies somewhere in between.
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