Leonid Hurwicz of the University of Minnesota, Eric S. Maskin of the Institute for Advanced Study, and Roger B. Myerson of the University of Chicago on Oct. 15 received the Nobel memorial prize in economics for having laid the foundations of mechanism design theory.
The theory developed by Mr. Hurwicz, professor emeritus of economics, and refined by Mr. Maskin, a professor of social science, and Mr. Myerson, professor of economics, shows how to deal with real-world situations when there is a breakdown of perfect competition and freely available information, according to Bruce I. Jacobs, principal, Jacobs Levy Equity Management.
According to a Nobel Foundation statement, the theory shows why markets are typically the most efficient way to allocate resources, even in less than ideal conditions, but also shows why government intervention can be justified in markets ill-suited for allocation of public goods and identifies what regulatory and taxation schemes promote optimum efficiency.
The three new laureates will share equally the 10 million Swedish krona ($1.5 million) from the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, awarded by the Royal Swedish Academy of Sciences.
In general, this is an approach that is not only applicable but necessary when it comes to managing money, Mr. Jacobs said in an e-mail response to questions about the theory. While there are many theories, including the Capital Asset Pricing Model and Black-Scholes-Merton option pricing theory, that seem to work fine when conditions are just so, you cant bet the farm on them without making adjustments for the many vicissitudes of real-world markets.
Michele Gambera, chief economist of Morningstars Ibbotson Associates unit, said one of the more useful applications (of the three professors work) is to provide a way to compensate investment managers to meet performance objectives. The theory is also useful for designing stock-option compensation incentives for employees, Mr. Gambera added.