Tagged: Larse Peter Hansen

Irrelevant Sideshows

They keep you from getting lost in irrelevant sideshows.

That’s how University of Chicago economics professor John Cochrane described the benefits of asset-price models in a WSJ piece yesterday about Nobel winners Eugene Fama, Lars Peter Hansen and Robert Shiller.

Two alert readers sent me notes when the Royal Swedish Academy of Sciences proclaimed the recipients. Our models here also depend on measuring prices and behaviors in combination, concepts these fellows pioneered.

Like the cowboy adage on how to double your money (fold it over and put it back in your pocket – something Washington DC could stand to grasp), both John Cochrane’s quip and the work these gentlemen have done simplifies the complex.

We can thank them for much of what we know today about financial-market behavior, from the rational to the psychological. We understand that markets are generally efficient but occasionally random, that risk affects investment behavior and outcomes and how we perceive value.

Behavioral finance owes them too for its modern prominence in everything from high-frequency trading models to the Federal Reserve’s beige book of key economic indicators.

We today broadly recognize Robert Shiller’s Case-Shiller Home-Price Index, which measures average prices against the rate of change in them. Shiller’s work in the 1970s served as seedbed for behavioral finance.

Investor-relations at root is fostering fair value. Yet here we arrive at a remarkable confluence of rationality and psychology. IR embraces the rational-investor thesis but generally rejects behavioral finance – the basis for arbitrage – when quantifying market-behavior. One is relevant, the other a distraction not worth measuring. Yet Nobel Prizes have been awarded for work demonstrating behavioral effects in asset-price models. (more…)