Computer models have battled to find economic forecasts over the past four decades through use of efficient vs. inefficient markets. Harry Markowitz, a 1990 Nobel Prize winner and leading economist had developed asset allocation theory to place the optimum percentage allocation of the asset classes by risk tolerance. His theory was tested after the global meltdown of October 2008. Did the Markowitz model of asset allocation not provide for inefficient markets?
The Nobel Prize committee recognized Oct.15 three economists; all independent of each other have dealt with the efficient vs. inefficient markets in different theories to win this year's Nobel Prize in economics. Robert J. Shiller, Eugene Fama and Lars Peter Hansen will share this split of the $1.25 million dollar award this December in Stockholm, Sweden.
Robert J. Shiller won based upon his description of the rapid rise of housing prices could fall and termed the upcoming situation a “bubble”. Because Mr. Shiller does not believe in rationale markets, he wrote in his 1989 book, “Market Volatility,” that the assertion that stock prices were rational was a remarkable error in the history of economic thought. “Mass psychology may well be the dominant cause of movements in the price of the aggregate stock market."
Mr. Fama does not agree with Mr. Shiller’s record as a forecaster, since this was one forecast sample. Mr. Fama believes in efficient markets. The debate on forecasting “bubbles” is heated with Mr. Fama, who has been quoted as saying, “I don’t even know what a bubble means.” As home prices begin a return in buying trend, Mr. Fama still does not believe that there has been a bubble.
Mr. Lars Peter Hansen developed a method of statistical analysis to evaluate theories about price movements that is now widely used by other social scientists. His work is based upon econometric models which is a forecasting tool to predict future economic performance based upon calculation of variables that affect the future outcome.
It is very simple to understand that variables such as employment, income, taxes and other variables can be weighted to produce a future prediction of the economy. In this simple understanding, it is easy to create a bridge between Shiller and Fama.
Eugene Fama and Pars Peter Hansen are from the University of Chicago, while Mr. Shiller represents Yale.