Nobel Prize in Economics 2013: Fama, Hansen and Shiller on Asset Prices

This note covers the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2013: who won it, what "empirical analysis of asset prices" means, how short-term and long-term predictability differ, what tools Eugene Fama, Lars Peter Hansen and Robert Shiller built, how the discovery unfolded, why it matters for investors and policymakers, and quick facts for exams.

What was the Nobel Prize in Economics 2013 awarded for?

The official citation reads: "for their empirical analysis of asset prices". In plain words, the three laureates studied how the prices of shares, bonds and other financial assets actually behave in real data, rather than just in theory, and asked a basic question: can you predict where a price is heading?

They found two things that at first look contradictory. Over a few days or weeks, asset prices are almost impossible to forecast, because new information gets absorbed into prices very quickly.

But over several years, broad swings in prices become somewhat foreseeable, because prices sometimes drift far from the level that dividends or earnings alone would justify, and then tend to correct.

The prize's official name is the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, commonly called the Nobel Prize in Economics.

The Royal Swedish Academy of Sciences, which awards this prize, said the laureates had "laid the foundation for the current understanding of asset prices", resting partly on fluctuations in risk and partly on behavioural biases and market frictions.

Who are the laureates?

Eugene F. Fama

Eugene F. Fama was born on 14 February 1939 in Boston, Massachusetts, USA. At the time of the award he was affiliated with the University of Chicago, Chicago, Illinois, USA, where he held the Robert R. McCormick Distinguished Service Professorship in Finance. He received one third of the prize.

Fama studied at Tufts University before earning his PhD from the University of Chicago in 1964, and stayed there for his whole career.

Beginning in the 1960s, he showed through careful statistical tests that stock prices are extremely difficult to predict in the short run, because new public information is absorbed almost instantly.

This became known as the efficient-market idea, and it shaped the rise of index funds that simply track the whole market rather than trying to beat it.

Lars Peter Hansen

Lars Peter Hansen was born on 26 October 1952 in Urbana, Illinois, USA (his Nobel facts page says Champaign, Illinois).

At the time of the award he was at the University of Chicago, where he held the David Rockefeller Distinguished Service Professorship in Economics and Statistics. He received one third of the prize.

Hansen studied at Utah State University and received his PhD from the University of Minnesota in 1978. He worked at Carnegie-Mellon University from 1978 to 1981 before moving to Chicago.

In 1982 he developed the Generalized Method of Moments (GMM), a statistical technique suited to the awkward features of asset-price data, which let researchers rigorously test theories about how risk and prices connect.

Robert J. Shiller

Robert J. Shiller was born on 29 March 1946 in Detroit, Michigan, USA. At the time of the award he was affiliated with Yale University, New Haven, Connecticut, USA, as Sterling Professor of Economics. He received one third of the prize.

Shiller studied at Kalamazoo College and the University of Michigan, then earned his PhD from MIT in 1972. He has been linked to Yale since 1982.

In the early 1980s he found that stock prices swing far more than company dividends do, and that this excess volatility implies prices are somewhat predictable over three to five years, a finding that helped start the field of behavioural finance.

What problem were the laureates trying to solve?

Asset prices matter for almost everyone, not only professional traders. A household deciding whether to hold cash, a bank deposit, shares, or a house is really betting on the risk and return of each choice.

Prices of shares and bonds also feed into company investment decisions and the wider economy, because they tell firms and savers where capital should flow.

The trouble is that prices do not always track what economists call fundamental value, meaning the properly discounted value of the future income an asset will generate.

History shows episodes labelled bubbles and crashes, where prices move far from any sensible estimate of future earnings, and the Academy noted that such mispricing can contribute to financial crises that damage the whole economy.

So the central question the laureates tackled was twofold: first, can price movements be predicted at all, and second, if certain patterns of predictability exist, do they reflect markets working well (fair compensation for risk) or markets working badly (irrational mispricing)? Answering this needed new data analysis and new statistical tools, which is exactly what the three laureates supplied, each from a different angle.

How did Fama show that short-term prices are hard to predict?

Fama's approach rested on a simple but powerful idea: in a market that works well, any price pattern that investors could reliably exploit would itself get traded away.

If everyone expected a stock to jump in value next week, they would buy it now, pushing today's price up until the easy profit vanished. What remains is largely random movement driven by the arrival of genuinely new, unpredictable information.

He tested this using the following broad method, described in the sources as building on earlier work and then systematising it:

1. Collect long historical series of daily, weekly and monthly share prices.
2. Check for serial correlation, meaning whether today's price change helps predict tomorrow's.
3. Run "runs tests" to see whether strings of rising or falling prices occur more often than chance would allow.
4. Apply "filter tests" that mimic simple trading rules to see if they would have made money.
5. With colleagues Fisher, Jensen and Roll, study event studies: track a stock's price just before and after a specific announcement, such as a stock split, to see how fast the price reacts.

The 1969 event-study paper on stock splits found that prices adjusted to news almost immediately, with no further drift afterwards once dividend effects were separated out.

This supported what the Academy called a market that works well in the short run: new information is absorbed quickly, so past prices tell you very little about tomorrow's price.

Draw a horizontal time axis running from 12 trading days before an announcement to 12 trading days after it, marked at day 0.

Draw a line that stays roughly flat before day 0, jumps sharply upward at day 0 (an example in the source shows about a 5% jump), and then stays flat afterwards, showing no further predictable drift.

How did Shiller and Hansen find predictability over longer horizons?

If short-term prices are nearly unpredictable, it might seem that longer-term prices should be even harder to forecast. Shiller's research in the early 1980s showed the opposite.

He compared the actual ups and downs of stock prices with the much smoother path of the dividends those stocks eventually paid out, and found that prices swing far more than dividends can explain.

This excess swinging matters because it implies a pattern: when the ratio of price to dividends is unusually high, it tends to fall back over the next few years, and when that ratio is unusually low, it tends to rise.

Shiller and later researchers found this mean-reverting pattern not only in shares but also in bonds and other assets, meaning returns over three to five year (and in the ceremony speech, three to seven year) spans do show some predictability.

The open question was how to interpret this. One possibility is that it simply reflects rational investors demanding more compensation for holding risk in unusually risky times, so apparent predictability is just a fair risk premium.

Testing this required a tool able to handle the tricky statistical properties of financial data. Hansen supplied it in 1982 with the Generalized Method of Moments, summarised here as a process:

1. Write down a theoretical pricing equation linking an asset's price to its expected future payoffs, discounted by a factor that depends on investors' attitude to risk.
2. Translate the theory's implications into statistical conditions, called "moment conditions", that the data should satisfy if the theory is correct.
3. Estimate the unknown parameters of the model directly from historical price and consumption data using GMM, without needing to assume the data follow a particular simple distribution.
4. Test whether the fitted model's predictions match the observed patterns of risk and return.

Using GMM, Hansen and others tested the standard risk-based model known as the Consumption Capital Asset Pricing Model and found it could not fully explain the scale of price swings Shiller had documented.

This confirmed that something beyond simple risk compensation was going on, and it pushed research in two directions: refining rational theories of risk, and exploring "behavioural finance," which allows for investors who are not fully rational and for market frictions, such as borrowing limits, that stop clever traders from correcting mispricing at scale.

Draw two lines over many decades on the same time axis: one jagged line showing the actual stock price index moving sharply up and down, and one much smoother line showing the discounted value of dividends the stocks actually paid afterwards, to show that the price line swings far more widely than the dividend line.

What did the laureates find about differences across individual stocks?

Besides asking whether the whole market is predictable over time, the laureates (mainly Fama) also studied why some individual stocks earn higher average returns than others, a question the sources call the cross-section of asset returns.

The classical theory for this, the Capital Asset Pricing Model, says a stock's expected return should depend only on how strongly it moves with the overall market.

Fama tested this idea across large numbers of stocks and found that correlation with the market was not the main driver of differences in average returns.

Instead, two other factors mattered much more: a company's size (its total market value) and its book-to-market ratio (accounting book value divided by market value).

Large companies, and companies with a low book-to-market ratio, tended to earn lower subsequent returns on average, while smaller or so-called "value" stocks with high book-to-market ratios tended to earn more.

This resembled Shiller's finding at the level of the whole market: just as a low valuation relative to dividends predicted higher future market returns, a high book-to-market ratio for an individual stock predicted higher future stock returns.

Researchers have debated whether this reflects extra, badly-measured risk that value and small stocks carry, or whether it reflects investor behaviour that misprices such stocks, echoing the same rational-versus-behavioural debate found in the market-wide results.

How did the discovery unfold?

Why does this work matter?

The laureates' findings reshaped both academic research and everyday financial practice. Because short-term stock-picking is so hard to do reliably, studies have generally failed to find that actively managed mutual funds beat the market once fees are subtracted, which is part of why index funds, which simply hold the whole market cheaply, have grown so popular worldwide.

Event-study methods built on Fama's work are now routinely used to measure how markets value corporate actions such as mergers, stock issues or takeover bids, which is useful both for companies deciding on such moves and for regulators assessing their effects.

Shiller's insight that some risks are hard to insure against directly led to the construction of the Case-Shiller housing price index, a tool investors use to track housing-price trends.

Open questions remain. The Academy noted it is still too early to say how much long-run predictability reflects natural, rational swings in risk and how much reflects genuine mispricing by less-than-fully-rational investors.

Understanding exactly when and why markets fail to reflect available information efficiently, the Academy said, is a leading question for future research, with answers likely to depend on the specific market and institutional setting.

How does this connect to what you study?

This prize connects directly to topics in economics classes on financial markets, investment and risk, as well as to statistics classes that teach how to test theories against real data.

The idea that a well-functioning market quickly absorbs new information, so prices become hard to predict, links to broader lessons on how markets allocate resources through prices and respond to news.

The idea that investors demand extra return for taking on risk connects to basic concepts of risk and return taught alongside savings, insurance and investment choices, including why a risky share is expected to pay more on average than a safe government bond.

Students who later study statistics will also meet the general problem Hansen's method addresses: how to test a theory honestly using real-world data that does not behave as neatly as textbook assumptions suggest, since financial data often has features that simple statistical methods struggle with.

The debate between rational and behavioural explanations for price swings also connects to psychology and decision-making topics, since it asks whether investors always act logically or sometimes let emotion and bias affect their choices.

Finally, the growth of index funds as a practical outcome of this research is a useful real-world example when studying how academic findings can change everyday financial behaviour, from how individuals save to how large pension funds invest.

Quick facts for exams

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2013, widely called the Nobel Prize in Economics, was announced on 14 October 2013 by the Royal Swedish Academy of Sciences.

It was shared equally among three American economists: Eugene F. Fama and Lars Peter Hansen, both of the University of Chicago, and Robert J. Shiller of Yale University.

The official citation praised their work "for their empirical analysis of asset prices". Fama showed short-term price movements are hard to predict because markets absorb news quickly;

Shiller showed longer-term prices show more predictability because they swing more than dividends justify; and Hansen built the statistical Generalized Method of Moments used to test risk-based pricing theories against real data. The prize amount that year was 8,000,000 Swedish kronor.

Note: Source. The prize facts in this note are from the Nobel Prize's official site, nobelprize.org.

Glossary

• Asset price — the price at which a financial asset such as a share or bond trades in the market.
• Efficient market — a market where prices quickly absorb available information, making further predictable gains hard to find.
• Event study — a method that examines how a stock's price moves before and after a specific piece of news.
• Random walk — a price pattern where future changes are unpredictable from past values.
• Excess volatility — the finding that stock prices move much more than the dividends that follow would justify.
• Generalized Method of Moments (GMM) — a statistical technique for testing economic theories against data without assuming a simple distribution.
• Behavioural finance — a field that studies how psychological biases and institutional limits affect asset prices.
• Book-to-market ratio — a company's accounting book value divided by its market value, used to classify "value" stocks.
• Index fund — a fund that simply holds a broad basket of assets to track the market rather than trying to beat it.
• Risk premium — the extra average return investors demand for holding a riskier asset.
• Mean reversion — the tendency for unusually high or low price ratios to move back towards typical levels over time.
• Dividend-price ratio — a company's dividend payment divided by its share price, used to help forecast future returns.

Common errors and misconceptions

• Misconception: Fama and Shiller's findings directly contradict each other. Correct: They apply to different time horizons: Fama's work concerns short-run (days or weeks) predictability, while Shiller's concerns longer-run (years) predictability.
• Misconception: An efficient market means prices are always correct. Correct: Efficiency, as used here, means prices absorb available information quickly; it does not guarantee prices equal true fundamental value at every moment.
• Misconception: Shiller proved markets are irrational. Correct: He showed prices are more volatile than dividends justify; interpreting this as irrationality is one possible explanation among others discussed in the sources, including risk-based explanations.
• Misconception: Hansen's GMM proved the standard risk-based theory was completely wrong and useless. Correct: GMM showed the basic version of the theory could not fully explain the data, which led to refined versions rather than abandonment of risk-based thinking.
• Misconception: All three laureates worked on exactly the same question in exactly the same way. Correct: Each contributed a distinct piece, short-run predictability, long-run predictability and statistical testing methods, that together built a fuller picture.
• Misconception: The prize rewards a single joint discovery made together. Correct: The citation covers their separate, complementary empirical analyses of asset prices over different periods of research.

Exam-style questions with model answers

Q1. In which year was the 2013 Nobel Prize in Economics announced? [1 mark]

1. It was announced on 14 October 2013 by the Royal Swedish Academy of Sciences.

Q2. State the official citation for the 2013 Nobel Prize in Economics. [2 marks]

1. The citation was "for their empirical analysis of asset prices".
2. It was awarded jointly to Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller.

Q3. Explain what Eugene Fama's event studies found about stock prices. [4 marks]

1. Fama, together with Fisher, Jensen and Roll, studied how stock prices reacted around specific news events such as stock splits.
2. They found that prices adjusted to new information almost immediately, with no further systematic drift afterwards once dividend effects were accounted for.
3. This supported the idea that markets are efficient in the short run, since past prices and even recent news could not be used to predict further gains.
4. The finding influenced the rise of index funds, since it suggested beating the market through short-term trading was very difficult.

Q4. Explain Robert Shiller's finding on excess volatility and what it implies. [4 marks]

1. Shiller compared actual stock prices with the discounted value of the dividends those stocks later paid.
2. He found that prices swung far more widely than dividends could justify under a simple theory with a constant discount rate.
3. This excess volatility implies a pattern of mean reversion: when prices are high relative to dividends, they tend to fall over the following years, and vice versa.
4. This means that, unlike very short-run prices, market returns over several years show some genuine predictability.

Q5. Discuss how the work of Fama, Hansen and Shiller together built the modern understanding of asset prices. [6 marks]

1. Fama showed that in the short run, over days or weeks, stock prices are very difficult to predict because new public information is absorbed into prices almost instantly, an idea linked to market efficiency.
2. Shiller showed that over longer horizons of several years, prices do show predictable patterns, because they swing more widely than the dividends paid by the underlying companies, implying some mean reversion.
3. These two findings seemed to sit in tension: how can prices be unpredictable in the short run yet show patterns over years?
4. Hansen resolved part of this by developing the Generalized Method of Moments in 1982, a statistical tool able to test whether risk-based theories, such as the Consumption Capital Asset Pricing Model, could explain the scale of price swings.
5. Using GMM, researchers found that the basic risk-based theory could not fully explain the observed volatility, which pushed research in two directions: refining rational, risk-based theories, and developing behavioural finance, which allows for less-than-fully-rational investors and market frictions.
6. Together, the three laureates' empirical and statistical contributions became the foundation for how economists now study whether, and why, asset markets deviate from simple efficient pricing.

Q6. What practical effect did this research have on the investment industry? [3 marks]

1. Because research found it was very hard for most actively managed funds to beat the market consistently after fees, the findings supported the growth of index funds that passively track the whole market.
2. Event-study methods built on this work are also used to measure how markets value corporate actions like mergers and stock issues.
3. This made investors and regulators more cautious about paying high fees for active fund management, since actively managed funds often underperform the market once fees are taken into account.

Key takeaways

• The 2013 Nobel Prize in Economics went jointly to Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller for empirical analysis of asset prices.
• Fama found stock prices are very hard to predict over short horizons such as days or weeks.
• Shiller found stock and bond prices show predictable swings over longer horizons of several years.
• Shiller's excess-volatility finding showed prices move far more than dividends alone can explain.
• Hansen's Generalized Method of Moments, developed in 1982, let researchers rigorously test risk-based pricing theories.
• Fama also found a stock's size and book-to-market ratio predict average returns better than simple market correlation alone.
• The findings helped drive the growth of index funds and shaped the Case-Shiller housing price index.
• Researchers still debate how much long-run predictability reflects rational risk compensation versus genuine mispricing.

Test yourself

Where was Eugene Fama affiliated at the time of the 2013 award?

Eugene Fama was affiliated with the University of Chicago in Chicago, Illinois, USA, at the time of the award.

Which university was Robert Shiller linked to when he won the prize?

Robert Shiller was affiliated with Yale University in New Haven, Connecticut, USA.

What statistical method did Lars Peter Hansen develop in 1982?

Hansen developed the Generalized Method of Moments, a technique for testing risk-based theories of asset pricing against real data.

What did Fama's event study of stock splits find?

It found that stock prices adjusted to news almost immediately, with no predictable drift in prices afterwards.

What did Shiller find when comparing stock prices with dividends?

He found that stock prices swing far more than can be explained by the dividends those stocks later paid, called excess volatility.

What two factors did Fama find predict a stock's average return better than market correlation alone?

He found a company's size and its book-to-market ratio predicted average returns better than simple correlation with the market.

How much was the prize amount for the 2013 Nobel Prize in Economics?

The prize amount was 8,000,000 Swedish kronor, shared equally among the three laureates.