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Nobel prize winners in Economics Science

Nobel winners. From left to right: Eugene F. Fama, Lars Peter Hansen, and Robert J. Shiller won the Nobel Memorial Prize in Economic Sciences on Monday.

Stock-Pricing Theorists Reap Economics Nobel

Predicting how stock prices will rise or fall, everybody knows, is worth a fortune. Understanding the predictability of stock prices, too, can net you a pretty rich dividend, as Eugene Fama, Lars Peter Hansen, and Robert Shiller can tell you this morning. The three have together won the 2013 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (informally, the Nobel Prize in economics) “for their empirical analysis of asset prices.” Fama and Hansen are professors at the University of Chicago; Shiller is a professor at Yale University.

In the 1960s, Fama and his colleagues showed that it was impossible to predict stock prices in the short term because any new information that might influence a particular stock—such as new, tougher environmental regulations affecting the oil industry—was quickly incorporated into the stock price. Fama’s findings led to the emergence of index funds, enabling millions of households to invest in the stock market without spending the huge time and effort investors had been spending trying to determine how individuals stocks would fare over days and weeks.

In the 1980s, Shiller showed that although Fama was right, there was more to the story. When Shiller studied stock prices relative to the dividends earned by the stocks over the years, he found a pattern. Although theoretically, stock prices should follow the trend of the dividend stream, year after year, Shiller found that when stocks were priced higher than their dividends proved to justify, they fell in price in the following years in a way that made stock prices predictable over a 3- to 7-year horizon.

In 1982, Hansen developed a statistical method for testing the theory of how the savings and investment decisions of individuals affect stock prices. His work showed, among other things, that it was flawed to view investors as rational actors. In bad times, investors are far less willing to take risk; in good times, they are far more willing. Their pessimism and optimism influences stock prices in ways that earlier models did not account for. Hansen’s work, along with the work of others, laid the foundations of behavioral finance.

Shiller spoke to reporters briefly by phone at the Nobel Committee’s press conference announcing the prize. He expressed gratitude that the field of finance had been recognized. “I believe that finance is a theory that while it has many controversial elements also has a body of knowledge that is useful to society and will improve human welfare,” he said.