Carmel Fisher - Nobel prize for economics confirms markets behave randomly

A funny thing happened this week – three American economists, two of whom have seemingly conflicting theories, shared the 2013 Nobel prize for economics.  Their prize-winning idea? That wild swings in asset prices can cause havoc!

Well, it’s not quite as simple as that, but the naming of Robert Shiller, Eugene Fama and Lars Peter Hansen as Nobel prize winners had a few scratching their heads.    

Yale professor Robert Shiller is probably the best known, having successfully predicted the dotcom bust in 2000 and the US housing crash seven years later.  His Shiller price-to-earnings ratio is used by investors around the world to spot looming overvaluation.  

Chicago professor Eugene Fama is known for his work that shows stock movements are a "random walk" and cannot be predicted in the short run.   He believes that it is folly to try to beat the market, and Fama is considered responsible for the popularity of index funds that don’t attempt to pick stocks.  

While Fama talks about rational markets, arguing that investors respond to known facts, Shiller regards markets as irrational and driven by emotion.  

Professor Hansen is an expert in mathematical modelling and cautions that “we often underestimate how much uncertainty there is”.

In awarding the three economists the prize, the Royal Swedish Academy of Sciences said that “mispricing of assets may contribute to financial crises and, as the recent global recession illustrates, such crises can damage the overall economy.”

You can’t argue with the logic, it just might have been more impressive if the trio had reached agreement and found a way to use their research to consistently predict looming crises and avoid them.

While justifiably proud of the Nobel prize – which has been won by Americans 300 times compared to the United Kingdom and Germany at 100 each – some Americans are sceptical.  

One blogger questioned why with so many Americans winning prizes in economics, the nation continues to spend beyond its means forcing it to borrow forever to pay its bills.  Others say that the trio of economists merely stated the obvious (as financial bubbles have been bursting since time immemorial) and should not share the podium with real scientists who make significant contributions in the field of medicine, chemistry, physics and literature.  

The other niggle is that the economics prize is not a “true” Nobel prize, but rather was sponsored as a memorial to Nobel by Sweden’s central bank in 1968.  The notion of an award, paid for by a bank to legitimise the ‘science of economics’ which has failed to avert so many financial crises does not sit well with everyone!

One economist even waded in to the discussion saying “a good test in medicine is whether the recipient's research has saved a million lives.  In economics it's about writing down clever squiggles on diddles that mostly gets rewarded”.

But let’s not be uncharitable, there must be something to take from this year’s prize.  The fusion of the trio’s research boils down to this – we know that markets behave randomly and efforts to time the market are probably counterproductive.