Three Economists Walk into a Bar

Earlier this year, three American Economists were awarded the prestigious Nobel Prize in Economic Sciences. It’s a bit curious to me that these men did not come to the same conclusion, on the contrary, their views contradict each other. Let’s spend a few minutes and look at their work so the next time you walk into a bar or cocktail party, you’ll be able to talk about these guys as if you knew them.

Eugene Fama – The developer of The Efficient Market Hypothesis (EMH), Fama’s work is well known to anyone who has taken even an introductory economics course. In simple terms, EMH states that the current price of a stock reflects all that is known about the company and investors cannot consistently earn excess returns over a long period of time. Fama even explained that with the huge number of fund managers around the world that there’s going to appear to be a number of star performers, but in the aggregate, they are going to lag the average market return.

Robert Shiller – Author of “Irrational Exuberance,” and one of the relative few who saw the mid 2000 housing bubble, Schiller  studied market movements and concluded that the volatility of the stock market was greater than could be explained by any rational view of the future. This view is in conflict with EMH, and further suggests that a mechanism exists to understand the market relative valuation, namely PE/10 the trailing ten year price to earnings ratio. Shiller’s name is frequently mentioned in the news as reporters discuss the valuation of the Case-Shiller index, a measure of relative housing prices.

Lars Peter Hansen – Hansen has focused on statistical models, creating ways to test competing theories of why asset prices move as they do. Of the three winners, Hansen’s work is lesser known, in a sense his work served as referee between te views of Fama and Shiller.

In sum – Fama – Efficient Market; Shiller – Irrational Exuberance; Hansen – Referee

Now you know. And the punchline to the title? I believe it’s, “and everyone in the bar walks out.” If you’ve hear a better finish, please let me know.