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    A joint Nobel Prize for opposing views

    Fatih Özatay, PhD19 October 2013 - Okunma Sayısı: 930

    Fama did not renew his subscription to the Economist because they made a large coverage on financial market bubbles after the global crisis.

    The Nobel Prize 2013 in Economic Sciences was awarded jointly to E. Fama, L. Hansen and R. Shiller for their contributions to our understanding of asset price movements: Hansen for developing a statistical method, and Fama and Shiller for their theoretical findings. I referred to their views in a series from January 2010 on the global crisis. The interesting part of the story is that point of views of Fama and Shiller were almost contradictory.

    The current price of any financial asset, say security or exchange rate, can be divided into two components: economic fundamentals and expected future price. For instance, for securities, the economic fundamental refers to the expected dividend payment. As it by name refers to the profitability of the relevant firm, it is a fundamental determinant of the price of security. Yet, the current price of the security depends also on the expectation on the future sales price. If you think the price will be higher in the future, you might be willing to pay a relatively higher price to purchase the security today. How these expectations are formed is critical as those can easily cause a bubble.

    Despite the increasing controversy, the common belief before the global crisis was that economic agents (consumers, corporate sector etc.) formed their expectations about the future rationally. Rational agents were supposed to seek their own interests and prevent their emotions and passions to interfere when they make decisions.

    Fama also belongs to this school; he has made important contributions in the field of financial market efficiency. In efficient financial markets, current prices reflect economic fundamentals. For financial markets, fundamental and bubble are two opposite concepts. If the price is based on the fundamental, any change in the price requires a change in the fundamental. For securities, the fundamental refers not only to the financial situation of the company but also to developments in the relevant sector, overall economy, and international and political circumstances.


    For instance, if there is an expectation for early elections, security prices change due to the change in fundamentals. There is no need that the expectation of each and every agent will be in the same direction, of course. What matters is a group of individuals and corporations large enough to influence prices with the purchases and sales they make form such expectations. If following this comes a well anticipated decision for early elections, prices do not change. A bubble-driven price, on the other hand, can change at any time and for any reason. The bubble eventually bursts by definition. But it is not definite precisely when it will burst.

    In an interview on the global financial crisis, Fama said he did not agree that there was a bubble formed in housing prices or housing mortgage loans before the global crisis. According to him, the rapid increase in these variables followed by a sharp decline was completely because of economic fundamentals. As an interesting note, Fama did not renew his subscription to the Economist because they made a large coverage on financial market bubbles after the global crisis. I will talk about Shiller later.

    This commentary was published in Radikal daily on 19.10.2013