Remember the 2004 crash in Sydney house prices? Neither do I. But Robert Shiller, one of three co-recipients of this year's Nobel Prize in economics, certainly does. Writing in the Wall Street Journal in 2005, Shiller claimed that Sydney suffered 'a pretty sharp bursting of their bubble' on the strength of a 2.5% decline in real house prices the previous year.
This is an extraordinarily low threshold for declaring a burst asset price 'bubble'. No surprise then that Shiller sees 'bubbles' everywhere. He is consequently credited with having foreseen recent asset price busts, but with such a low 'bubble' threshold, it would be more surprising if he missed one.
Shiller is best known for demonstrating some long-run predictability in US equity returns, but the investment advice he has freely dispensed on this basis has been unfortunate to say the least. In December 1996, he declared that the Standard & Poor's 500 would show no real appreciation over the next 10 years and 'long run investors should stay out of the market for the next decade.' US equities saw annualised returns of 5.89% after inflation and the reinvestment of dividends over the following decade, including the bear market from 2000 to 2003.
Eugene Fama, a co-recipient of this year's Nobel, developed the efficient market hypothesis (EMH). Its central, but widely misunderstood, claim is that asset prices are generally informationally efficient and therefore not forecastable (although like Shiller, Fama also found some long-run predictability in asset prices). A boom and bust in asset prices is not inconsistent with the EMH. As John Cochrane notes, 'given the large average returns of the stock market, it would be inefficient if it did not crash occasionally.' Fama famously cancelled his subscription to The Economist 'because they use the word "bubble" three times on every page.'
Shiller argues that the EMH 'is one of the most remarkable errors in the history of economic thought.' Yet his own track record in calling markets speaks to its validity. While it is unlikely we will ever see a definitive empirical test of the EMH, many of Shiller's ideas about 'bubbles' are not testable at all. He freely admits that 'one cannot decisively prove the stock market has been irrational.' Unfortunately, the Nobel Prize will lend increased authority to that part of Shiller's work that is more assertion than science.
The economics Nobel is constituted on a different basis to the other Nobel prizes, leading some to question whether it is a 'real' Nobel. But as one laureate in economics is reported to have said, 'the prize money spends just as well as the other Nobels.'
Dr Stephen Kirchner is a Research Fellow at The Centre for Independent Studies.
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Efficient markets in Nobel Prizes
This is an extraordinarily low threshold for declaring a burst asset price 'bubble'. No surprise then that Shiller sees 'bubbles' everywhere. He is consequently credited with having foreseen recent asset price busts, but with such a low 'bubble' threshold, it would be more surprising if he missed one.
Shiller is best known for demonstrating some long-run predictability in US equity returns, but the investment advice he has freely dispensed on this basis has been unfortunate to say the least. In December 1996, he declared that the Standard & Poor's 500 would show no real appreciation over the next 10 years and 'long run investors should stay out of the market for the next decade.' US equities saw annualised returns of 5.89% after inflation and the reinvestment of dividends over the following decade, including the bear market from 2000 to 2003.
Eugene Fama, a co-recipient of this year's Nobel, developed the efficient market hypothesis (EMH). Its central, but widely misunderstood, claim is that asset prices are generally informationally efficient and therefore not forecastable (although like Shiller, Fama also found some long-run predictability in asset prices). A boom and bust in asset prices is not inconsistent with the EMH. As John Cochrane notes, 'given the large average returns of the stock market, it would be inefficient if it did not crash occasionally.' Fama famously cancelled his subscription to The Economist 'because they use the word "bubble" three times on every page.'
Shiller argues that the EMH 'is one of the most remarkable errors in the history of economic thought.' Yet his own track record in calling markets speaks to its validity. While it is unlikely we will ever see a definitive empirical test of the EMH, many of Shiller's ideas about 'bubbles' are not testable at all. He freely admits that 'one cannot decisively prove the stock market has been irrational.' Unfortunately, the Nobel Prize will lend increased authority to that part of Shiller's work that is more assertion than science.
The economics Nobel is constituted on a different basis to the other Nobel prizes, leading some to question whether it is a 'real' Nobel. But as one laureate in economics is reported to have said, 'the prize money spends just as well as the other Nobels.'
Dr Stephen Kirchner is a Research Fellow at The Centre for Independent Studies.
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