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Earlier today, the Nobel committee announced three winners of the prize in economics: Eugene Fama, Robert Shiller, and Lars Peter Hansen.
Although they didn’t work together, their research shared a theme: predicting how markets work.
In its statement, the Nobel committee wrote: “There is no way to predict the price of stocks and bonds over the next few days or weeks. But it is quite possible to foresee the broad course of these prices over longer periods, such as the next three to five years. These findings, which might seem both surprising and contradictory, were made and analyzed by this year’s Laureates.”
UNIDENTIFIED MAN: (Speaking foreign language)...
ROBIN YOUNG, HOST:
Earlier today, the Nobel committee announced three winners of the prize in economics, all Americans who didn't work together but studied trends in predicting how markets work. In the 1960s, Eugene Fama of the University of Chicago, known as the father of modern finance, showed how hard it is to predict stocks in the short term. Yale's Robert Shiller, he of the S&P Case-Shiller Housing Index, later showed they could be predicted in the long run.
And then there's Lars Peter Hansen of the University of Chicago. He joins us now. And Professor Hansen, first of all when you answered our call today, you said Lars here. We were thinking you should be saying Lars Hansen, Nobel winner from the University of Chicago.
LARS PETER HANSEN: I haven't quite digested all this yet.
YOUNG: Well, I was going to ask: How do you feel?
HANSEN: I was very surprised. I'm quite excited right now. I will have a better answer, just ask in a day or two, but this has all been - it's been a very exciting morning.
YOUNG: Well, if you think you're having a hard time digesting the fact that you won, we're all trying to digest why all three of you won. And we understand the committee wanted to fuse your findings to come up with a unified theory of how the markets work. So how would you describe your contribution?
HANSEN: I work on the kind of boundary between economics and statistics, that boundary field in economics called econometrics. I've done work with both developing and applying statistical methods that are aimed at trying to understand linkages between financial markets and the macro economy.
YOUNG: So you're taking economic theory and trying to apply it to what you see in the markets. And I'm understanding you're best known as developing something called the generalized method of moments or GMM. Now without exploding our heads, can you explain what that is?
HANSEN: When you do kind of statistical analyses of economic models, it's very nice to have the ability to do some things without having to do everything. So I want to study the linkages between financial markets and the macro economy. We need to have a fully - a full fleshed-out model of the entire macro economy, plus the financial markets, and we have to do all that simultaneously, whereas a way that you can study a piece of it without having to do the whole thing simultaneously.
YOUNG: Ah. So what might be one part that you might - one slice that you might look at?
HANSEN: So the slice that I would be interested in is, say, you know, there's - financial markets serve as barometers of the macro economy. You know, they also have to, like, encode things like investor risk aversion, and there's a whole variety of economic models that kind of tell us how these things ought to be connected.
And the methods that I was working on and the ones I've been applying are meant to help us understand how those - you know, what's good about those models and also what their limitations are. Part of what I'm interested in is, say, you look at things like financial market day, part of it is that that data says, well, how risk-averse are people. Part of it says, well, what do people think is going to happen in the future, things like that.
And what - you know, why is it that people are - as markets behave in a more risk-averse fashion some times than other times and why - and so economist-built models are aimed at trying to understand that. As people develop different theories, you want statistical methods that help you assess what's good and bad about those theories, kind of in what ways they work and kind of what ways they don't.
YOUNG: So if I've got you right, you're saying that economists do things take things like risk aversion and people's concerns about their future, and they build models on that, and you're trying to figure out maybe what's wrong with the models.
HANSEN: Yeah, what's right and what's wrong with them.
YOUNG: What's right and what's wrong.
HANSEN: And to some extent the role of a statistician is to also be the bearer of good news but also bad news.
YOUNG: Yeah, well, and we're understanding that your longtime colleague there in Chicago, Eugene Fama, is more of the invisible hand economist, believing that markets are generally rational, and they can sort out information; Robert Shiller more of a behavioral economics guy that, you know, markets can be driven by human psychology and behavior. We saw that in the housing bubble. What are you?
HANSEN: Where am I on this? I guess in some extent, I'm a little bit in between. I certainly am very sympathetic to markets and how to make markets work, but - you know, and understanding when they seem not to work why they might not work so well. I'm a cautious person when it comes to say, well, it's like now run and have the government go fix financial markets because I think it would be almost an impossible task.
But on the other hand, the type of questions that fascinate me now is kind of, in what sets of circumstances do these models that we have that, you know, involve, you know, rational beliefs and behavior, when might they work well, and when might they struggle.
I'm a scientist, so I have to look at what works best.
YOUNG: Well, and given that, as we go into debt ceiling deadline and a debate in Washington as to whether or not the government will default, people who say default will not cause the sky to fall and people who say it will, your sense of what will happen?
HANSEN: Well, I think it throws tremendous uncertainty into the economy in a way that's counterproductive. So I would very much like for them to work out solutions and solve the problem.
YOUNG: Lars Peter Hansen, one of three winners today of the Nobel Prize in Economics, what else would you want people to know about the economy that's not getting out there?
HANSEN: A question that really fascinates me right now is, you know, lots of people are rushing to work out new policies related to financial market oversight, to financial market regulation and the like, and they're doing this with very, very limited knowledge, that is this notion of producing things like counter-cyclical capital requirements on banks and the like.
And when you do policy, you have to take into account the uncertainty, and you have to take into account that economists don't have everything figured out, and we don't have all the linkages figured out, and I'd love to see that play a much more prominent role in terms of looking at policy recipes and prescriptions.
And I think, you know, my own is that should lead us to think hard about simple solutions instead of complicated ones.
YOUNG: But Professor Hansen, how could it not be a good idea to demand that banks have more cash on hand so that if their borrowers default, they don't go under?
HANSEN: Oh, I'm not opposed to having capital requirements, but the question is if you make them so-called counter-cyclical, it means that you connect them to a bunch of specific things going on in the economy. And if you don't understand the precise linkages, then your policy can have adverse consequences.
YOUNG: Ah, so you're saying just dig a little deeper as you make those demands.
HANSEN: Yeah, yeah, also the more vague the policy mandate is, the more open things are to discretion, and that adds to uncertainty in the financial markets.
YOUNG: Well Lars Peter Hansen, we're going to let you go because we know your phone's been ringing quite a bit today. Congratulations again, and what do you think you will do with your prize money?
HANSEN: I have no idea.
HANSEN: I haven't even thought about that.
YOUNG: I hear some little voices in the background, it might be needed at home. Professor Hansen, congratulations again. It sounds like this is a - had been quite a stunning day for you.
HANSEN: Yeah, thanks.
YOUNG: And again Professor Hansen will share a $1.2 million prize with economists Robert Shiller and Eugene Fama.
JEREMY HOBSON, HOST:
Surprising that you wouldn't think of what to do with the money beforehand.
YOUNG: Well, it's the shock of being noticed and recognized.
HOBSON: Well, one of the other stories we're following today, there is a new device that provides parents with detailed information about how their teenage children are driving. It tracks the driver's speed, how fast he or she is going, and the number of passengers in the car. But how do teenagers feel about this? We'll hear about it later today on ALL THINGS CONSIDERED. Back in a minute, HERE AND NOW. Transcript provided by NPR, Copyright NPR.