Wednesday, October 16, 2013

Law & Economics

The 2013 Nobel Prize in Economics winners were announced earlier this week and the award was shared by three U.S. Economists for their work on asset pricing.  Eugene Fama of the University of Chicago, Lars Peter Hansen of the University of Chicago and Robert Shiller of Yale University share this year’s prize for their separate contributions in economics research.

The work of the three economics is summarized very elegantly in the summary publication produced by The Royal Swedish Academy of Sciences titled “Trendspotting in asset markets”.  The combined economic contribution of the three researchers is described below:

The behavior of asset prices is essential for many important decisions, not only for professional inves­tors but also for most people in their daily life. The choice on how to save – in the form of cash, bank deposits or stocks, or perhaps a single-family house – depends on what one thinks of the risks and returns associated with these different forms of saving. Asset prices are also of fundamental impor­tance for the macroeconomy, as they provide crucial information for key economic decisions regarding consumption and investments in physical capital, such as buildings and machinery. While asset prices often seem to reflect fundamental values quite well, history provides striking examples to the contrary, in events commonly labeled as bubbles and crashes. Mispricing of assets may contribute to financial crises and, as the recent global recession illustrates, such crises can damage the overall economy. Today, the field of empirical asset pricing is one of the largest and most active subfields in economics.


 This year’s award has several implications for those of us interested in the legal side of law and economics.  First, Fama is the grandfather of the efficient capital market hypothesis, the foundation for fraud on the market, a economics elements incorporated into securities fraud litigation.

Second, Fama’s inclusion in the award is being heralded by some as a win, or vote of confidence, for free marketers whose regulatory view (that markets should be largely unregulated) rests on the fundamental assumption that markets are efficient.  On the other hand, Shiller’s inclusion in the award challenges the coup that can be claimed by free marketers because Shiller has long questioned the efficiency of the markets.  John Cassidy at The New Yorker writes “Shiller, in showing that the stock market bounced up and down a lot more than could be justified on the basis of economic fundamentals such as earnings and dividends, kept alive the more skeptical and realistic view of finance that Keynes had embodied in his “beauty contest” theory of investing.”  Market efficiency, or lack thereof, are key arguments against and for market regulations.  Trends in support for either theory or validation of one could signal future approaches to regulation.

Finally, the focus on asset pricing, particularly Fama’s work has some potential implications for the mutual fund industry.  Fama’s efficiency view of the markets largely discounts the value of actively managed funds, once costs and annual fees are deducted because the market, if efficient, cannot consistently be beaten.  This last thread regarding fund management is a theme woven into some of my more recent research on the regulations, risks, and ownership anomalies facing retirement investors.  More on this later, with links to newly published papers of course, but for now read the Nobel summary document included above and briefly contemplate taking the time to audit an economics course next semester—I am going to browse the b-school catalogue now.

-Anne Tucker

Anne Tucker, Current Affairs, Financial Markets, Securities Regulation | Permalink


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