Eugene F. Fama, Robert J. Shiller and Lars Peter Hansen on Monday were named co-winners of the Nobel Memorial Prize in Economic Sciences for their “empirical analysis” from their different angles of how to predict securities prices, research that has profoundly influenced investment management practices, according to a statement from the Royal Swedish Academy of Sciences.
Mr. Fama — Robert R. McCormick distinguished service professor of finance, University of Chicago Booth School of Business — was cited for his pioneering work developing the concept of market efficiency, a term he coined. Developed by him in the 1960s, the efficient market hypothesis is one of the foundational concepts of modern finance. The finding contends the pricing of stocks and bonds is efficient, reflecting all known information so investment strategies cannot gain an advantage over the long term, and led to the development of index fund investing.
In addition, Mr. Fama — one of the founders, shareholders and directors of Dimensional Fund Advisors, which was “built around his ideas,” — contributed to pioneering insights into effects on stock prices of market capitalization and value vs. growth characteristics, David G. Booth, chairman and co-CEO of Dimensional, said in an interview
Mr. Booth, a onetime University of Chicago research assistant of Mr. Fama's, said his influence “has been enormous. He is one of a small group (of academics who) has changed the field of finance.”
The academy also cited Mr. Fama's other work, including co-developing the three-factor model. It shows “over longer periods “stocks with small market capitalizations and high book-to-market ratios tend to provide higher returns than large-cap stocks with low book-to-market ratios,” Bruce Jacobs, principal, Jacobs Levy Equity Management, said in an e-mail, in responding to a request for comment.
Mr. Shiller — Sterling professor of economics at Yale University — questioned the efficient market hypothesis. He inspired work in the field of financial economics called behavioral finance, contending asset prices are too volatile to be reconciled by standard rationality and efficiency of modern portfolio theory, according to the Swedish academy. The field adapts psychological insights of investor biases in behavior to explain asset and market pricing fluctuations.
“While Mr. Fama's investigations have remained grounded in the assumption that investors behave in a rational manner, Shiller's examinations of stock price behavior have explored the new theories and techniques of behavioral finance to incorporate investor, sometimes irrational, psychology,” Mr. Jacobs said.
Mr. Hansen — David Rockefeller distinguished service professor in economics and statistics at University of Chicago —was cited for his pioneering development of an econometric and statistical method for testing work on asset pricing using a model he developed called the generalized method of moments, according to the Swedish academy statement. Using his methods, “Mr. Hansen and other researchers have found that modifications of these theories go a long way toward explaining asset prices.” His work in econometric methods also “examines the connection between the macroeconomy and financial markets” according to a University of Chicago statement.
Mr. Hansen's “findings broadly supported Shiller's preliminary conclusions” on asset pricing fluctuations, the Swedish academy's statement said.
“Empirical testing based on his GMM model has since been used to test newer research that retains the classic assumption that investors tend to behave rationally as well as research in the emerging field of behavioral finance that examines how investor biases and market frictions distort prices,” Mr. Jacobs said.
“Their work showed that asset prices are somewhat predictable in the long run (and) less so in the short run,” Mr. Jacobs said. “Their findings also helped explain the extent to which prices can be explained by the rational — and irrational — behavior of investors.”
“The concept of market efficiency and the implications of behavioral finance have had profound effects on investing, both fundamental and quantitative,” Mr. Jacobs added.
The three will share the award, formally called the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, of 8 million Swedish kronor ($1.23 million), amounting to $411,801 each.
