The Fama Quasi-Nobel: Posthumous Award for EMH?

They’re kidding, right?

Nope. They mean it.

What’s really weird is that he splits the award with Robert Shiller and some guy called Hansen who is an econometrician and thus unintelligible and largely irrelevant to sensible discussion of the economy.

Back to Fama and Shiller: there are a few ways to deal with this.

Take One:

Fama was the guy who created the Efficient Markets Hypothesis (EMH). Looked at strictly this theory tells us that there is nothing an investor can do to outfox the market. This is because all the information that is out there is incorporated in prices. Thus all those ads telling us about past performance and about clever investment strategies are simple hoaxes. The market is what it is, and neither you nor I can outwit it unless by dumb luck.

This interpretation of EMH means it is a still solid, relevant and good piece of work. The problem is that it is built on much of the same quicksand as its companion theories that posit rational behavior. And because it can be reduced to that dictum that “the market is what it is” it has little value to anyone other than obscure finance theorists. It says that incoming news will produce a different result tomorrow, so today’s market price has no implication or meaning for tomorrow’s price.

In a nutshell EMH is another example of the hermetically sealed reality-resistant thinking that dominates modern economics: the only quirks or rotten stuff sit outside the pristine and pure wondrous working of the marketplace. Which is why theorists like Fama are so ideologically hell bent against anything that appears to intrude into their precious markets. Especially governments.

Take Two:

But Shiller has devoted much of his professional career to pointing out that people are a bit less – perhaps a lot less – than rational. At least in the meaning Fama has for rational.

In particular Shiller achieved notoriety for his study of real estate prices and noting the rise of the bubble that so famously burst a few years back.

Bubbles would suggest that markets are somewhat less than rational and are inclined to significant overshooting, undershooting, and other total misinterpretations of information. This is hardly efficient. Indeed a quick look at Shiller’s work seems to imply that he has debunked EMH pretty well. Don’t forget that according to EMH a house priced $100 one day and $1,000,000 the next is entirely within the realm of rational experience. The difference simply reflects different information. Duh.

So the quasi-Nobel prize committee is backing both sides of a very important argument. One that has huge implications for, inter alia, bank regulation. Do we regulate banks because they are likely to get swept away by Shiller-like exuberance? Or do we leave well alone because they are embedded in the smooth rational workings of the financial market place a la Fama?

Take Three:

This is what I call the “Krugman cop-out”.

His argument is that, even though Shiller seems to have undone Fama, and even though the work of the two seems to be in contradiction, the award to Fama is still worthy. After all someone had to dig the hole Shiller’s work subsequently filled up. Krugman is taking the old academic high road and trying to focus on all that now discarded effort. Perhaps he’s mindful that his work could also be debunked one day, and so he has closed ranks.

Take Four:

My view is that the quasi-Nobel committee was on the brink of giving Fama the prize back in the mid 2000’s, but was stopped dead in its tracks by the crisis, the bursting of the bubble, and the disarray this meant for the Fama camp. The committee had to wait for the dust to settle and for Fama’s defenders to rally around. They also had to allow the public of anyone interested in the prize to lose sight of EMH amongst all the post-crisis confusion and exposure of economics generally. Then they had to get someone else to steal the headlines – Shiller is a terrific choice – so that few outsiders would notice.

In many ways the award is akin to posthumous recognition. It is a reward for hard work done in the service of a now debunked theory.

EMH still has its supporters or course. They are that hardy band of rationalists who still dominate much of the economics landscape and who strenuously fight to keep reality at bay. Most of them appear to live in Chicago, which rather calls into question their rationality. Doesn’t it?

Well I think so.

Addendum:

For those of you confused by my references to the “quasi-Nobel”, I should make myself clear. I refuse to recognize the economics prize as a Nobel prize. It isn’t. It is a prize funded, not the Nobel Foundation, but by the Swedish Central Bank who sub-contracts the entire bureaucratic side of the award to the Nobel committee. It is thus a “faux” or “quasi” Nobel prize.

Besides, does anyone really think economics deserves a Nobel prize? I mean really?