K.E.M. Strategic Partners LLC | 35 Village Road, Suite 100 | Middleton MA 01949 | P. 978-560-3404  |  F. 978.560.1623

 
 

Caring  |   Independent   |   Practical
Financial Services

Investment Read Time: 4 min

The Ivory Tower Changes Wall Street

For as long as there has been a stock market, investors have sought a reliable framework to determine the future direction of prices. Success has been elusive. But thanks to the work of three American economists, we operate today with a better understanding than prior generations of what determines an asset’s price.

For their work, Eugene Fama, Lars Peter Hansen, and Robert Shiller were awarded the 2013 Nobel Memorial Prize in Economics. We can see the impact of their research in the development of low-cost index mutual funds and a methodology for identifying when home prices may reach irrational levels.1

Eugene Fama

Fama is considered the father of the “efficient markets theory,” which postulates that markets are exceedingly good at incorporating all known information into the value of an asset, making it difficult to predict the short-term direction of a stock or bond.2

Fama is famous for describing market movements as nothing more than a “random walk,” discounting the efficacy of price-prediction models. This view led to the conclusion that investors could do as well, or even better, by investing in a passively managed index fund.

Index mutual funds are sold only by prospectus. Please consider the charges, risks, expenses, and investment objectives carefully before investing. A prospectus containing this and other information about the investment company can be obtained from your financial professional. Read it carefully before you invest or send money.

Robert Shiller

Shiller’s work brought us a different, even contradictory, view. His research suggested that mispricing of assets may occur because of human behavior, which can lead to excessively high or low prices relative to their true value. His work also focused on home prices, which employed a cost ratio between home prices and rent to ascertain fair value of current home prices. Shiller may be best known for his co-development of the Case-Shiller Home Price Index.

Lars Peter Hansen

Hansen’s research built on Shiller’s work, using statistical models to determine what drove market volatility. His work was more esoteric, but well valued by other economists. He concluded that the mispricings that Shiller had identified were connected to investors’ changing risk appetite. Hansen argued that investors become more risk averse during bad times and more aggressive during good times.

At first glance, it may be perplexing that the Nobel Committee awarded the prize to men espousing differing theories, but collectively, they made important contributions to our body of knowledge on how assets are priced.

1. Keep in mind that the return and principal value of stock prices will fluctuate as market conditions change. And shares, when sold, may be worth more or less than their original cost.
2. The market value of a bond will fluctuate with changes in interest rates. As rates rise, the value of existing bonds typically falls. If an investor sells a bond before maturity, it may be worth more or less than the initial purchase price. By holding a bond to maturity an investor will receive the interest payments due plus his or her original principal, barring default by the issuer. Investments seeking to achieve higher yields also involve a higher degree of risk.

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright FMG Suite.

Share |
 

Related Content

Pullbacks, Corrections, and Bear Markets

Pullbacks, Corrections, and Bear Markets

Pullbacks, corrections, and bear markets are all a part of the investing cycle. When the market experiences volatility, it may be a good time to review these common terms.

Beyond Breakfast-in-Bed: 5 Finance Gifts for Mother’s Day

Beyond Breakfast-in-Bed: 5 Finance Gifts for Mother’s Day

Depending on the mom, the right Mother’s Day gift can run the gamut from flowers to flatscreens, but this year why not try something a little different: the gift of financial confidence. Whether making a household budget or planning for retirement, there’s probably a mom in your life who can use one of these gift ideas:

Don’t Be Your Own Worst Enemy

Don’t Be Your Own Worst Enemy

Emotional biases can adversely impact financial decision making. Here’s a few to be mindful of.

 

Have A Question About This Topic?







Thank you! Oops!

Overlooked Ways to Add Diversity to Your Portfolio

It’s an exciting time for American investors. Recent years have seen a boom in Americans investing in the stock market, with Goldman Sachs estimating U.S. households will spend $400 billion on equities in 2021, averaging an eyebrow-raising 44% allocation of their total assets to stocks. Between new technologies (like mobile trading apps) lowering the bar to entry and “meme stock” trends raising awareness, it’s no wonder so many people are waking up to the power and potential of investing.

Mortgages in Retirement

Explore the benefits and drawbacks to paying off your mortgage prior to retirement with this article.

Financial Fixes: From Health Scare to Financial Care

A medical scare can be a wake-up call in terms of your physical and financial health. Here’s how to strengthen your finances

View all articles

Interested in a Fuel Efficient Car?

Estimate how many months it may take to recover the out-of-pocket costs when buying a more efficient vehicle.

Bi-Weekly Payments

This calculator estimates the savings from paying a mortgage bi-weekly instead of monthly.

Home Mortgage Deduction

Use this calculator to assess the potential benefits of a home mortgage deduction.

View all calculators

Principles of Preserving Wealth

How federal estate taxes work, plus estate management documents and tactics.

5 Smart Investing Strategies

There are some smart strategies that may help you pursue your investment objectives

Your Cash Flow Statement

A presentation about managing money: using it, saving it, and even getting credit.

View all presentations

Timing Your Retirement

This short video illustrates why knowing when to retire can be a crucial part of your strategy.

When Special Care Is Needed: The Special Needs Trust

A special needs trust helps care for a special needs child when you’re gone.

Bridging the Confidence Gap

In the world of finance, the effects of the "confidence gap" can be especially apparent.

View all videos