Nobel Prize in Economics – Stock Market Pricing

Three economists who separately worked on how assets, especially stocks, are priced won the 2013 Nobel Prize in Economic Science. It’s an interesting collection of co-winners. One can argue that their research builds on each other, or one can argue that they are contradictory. I’ve reviewed several articles explaining the different research of the winners and think this is the best of those.

Most of the article miss a key point. Eugene Fama is the oldest of the three and is considered the main developer of the efficient market theory, demonstrating that it is very difficult to predict market prices and try to earn superior returns that way. That led to the development of index funds and other innovations. What most articles don’t mention is that in later research Fama admitted there are “anomalies” in the efficient market theory. These are strategies that can beat the market or an index consistently. In fact, he helped form Dimensional Fund Advisors, an investment firm that develops investment strategies to outperform various market indexes. That’s why I think the work of the three researchers is consistent, and the later work builds on the earlier work.

The awards are a “very interesting collection because Fama is the founder of the efficient market theory and Shiller at least is one of the critics of it,” said Robert Solow, winner of the Nobel economics prize in 1987 and professor emeritus at the Massachusetts Institute of Technology in Cambridge.

“It’s like giving a prize to the Yankees and the Red Sox,” he said, comparing the competing economic theories to the rivalry between the New York and Boston baseball teams. “It was just an indication that what they were interested in was all those that had contributed to the modern theory of finance at both ends of the spectrum.”