I went to the House of Sweden (Swedish Embassy in Georgetown) today to attend an award ceremony for the Nobel Prize winners Eugene Fama, Lars Hansen, and Robert Shiller for their work in the empirical analysis of asset prices. I will give some quick background on the winners and then a brief outline of what was said by these economic titans. There are some pretty interesting comments by the winners at the end of the post too!
Financial Analysis Is Useless (Or Is It?)
Fama is commonly known as the father or efficient-market hypothesis. He proposes there are three types of information efficiency that are factored into price trends of stocks (technical, fundamental and inside information, and all information). Fama, as he reiterated today, believes that no one in the world can predict market movements in the future because all information is immediately priced into stocks. This means that completing financial analysis to determine intrinsic value or looking at technical charts is completely useless and a waste of time. According to Fama, no one can predict the future accurately.
Shiller, on the other hand, thinks investors can identify when the market is over- or under-valued. In fact, Shiller himself predicted the last two major downturns in the economy. In 2000, Shiller published Irrational Exuberance in which he argued the market was over-valued. The market, a month later, tanked, and the Tech bubble burst. More recently, he predicted the 2008 housing crash.
Fama responds to Shiller’s predictions as “luck”. According to him, Shiller’s predictions are statistically irrelevant. He admits that if Shiller were to consistently identify downturns in the market in the future that he may have some sort of edge on the market. He is waiting to find out. Most interestingly, is that Shiller is also involved in behavioral economics, meaning that he studies the behavior of investors, in addition to evaluating the intrinsic value of companies. After all, not all investors think rationally. Many just play the market like a casino hoping for big gains. This may be how Shiller is able to call the next bubble (which he has not called yet). That means, as Shiller thinks, the market is not as efficient as Fama thinks it is.
Passive vs. Active Investing
Fama and Shiller’s ideas are the foundation of the debate over which is better: passive or active management of portfolios. Passive investors think it would be better to save time identifying good investments and instead invest in the overall market. Active investors believe that they can identify over- and under-valued investments through fundamental research and other supplemental tools such as technical analysis (identifying trends through stock price history) and behavioral economics (identifying trends in market sentiment that causes prices to move).
Raise Taxes and Inefficient Bureaucracies
Probably one of the most interesting comments during the ceremony was from Shiller. He thinks we should raise taxes to pay for more spending in the economy to get it going again. He did not say who we should raise taxes on, but he did indicate that it wouldn’t hurt that much, compared to the amount of economic gains that would result from additional spending. He also mentioned there is a flawed feedback loop after crises, meaning the reasons for the crises are not perfectly fixed following crises. His biggest comment was on the way mortgages are set up, and said that you can learn more about it in his book, the Subprime Solution.
Another interesting argument was made by James Rothman, a Nobel Prize winner in Physiology or Medicine. He said the government was not efficient in assigning research grants to individuals studying medicine. To the many immigrants that come to the US to do research, he recommends they go back to their home country to receive funding because they may not get funding here in the US. To fix this problem, he believes the US should spend more money on research grants while claiming the US has cut back on public funding over the years.
To lighten up the debate, Fama quickly fired back at Rothman, pointing out that if the government were to supply more money for research, it would crowd out private investment. Most in the room, including the other Nobel Prize winners, were not happy with Fama’s response. But Fama is right, according to economic textbooks, at least. However, the entire group appeared to agree that the way research is funded is not efficient, and perhaps funding should not be assigned through the government (or should be, but in a different way), which picks and chooses what research gets selected for funding.
Finally, the best comment.
One of the Nobel Prize winners in Chemistry couldn’t keep one of his final thoughts to himself. Nobel Prize winner Michael Levitt questioned whether economics is actually a science, because the way he sees it, the economic models economists use haven’t actually predicted anything. Levitt’s portfolio, apparently, is accustomed to wide swings in value and no one has been able to help him smooth his earnings.
Hope you enjoyed it!
What are your thoughts on what the Nobel Prize winners said?