Can we predict asset prices even over a long-term?

The committee releases superb summaries of  works of winners of “The Prize”. This year is no different.

I have so far only read the popular version as adv version is too detailed.

The popular version begins like this:

There is no way to predict whether the price of stocks and bonds will go up or down over the next few days or weeks. But it is quite possible to foresee the broad course of the prices of these assets over longer time periods, such as, the next three to five years. These findings, which may seem both surprising and contradictory, were made and analyzed by this year’s Laureates, Eugene Fama, LarsPeter Hansen and Robert Shiller.

Fama, Hansen, and Shiller have developed new methods for studying asset prices and used them in their investigations of detailed data on the prices of stocks, bonds and other assets. Their methods have become standard tools in academic research, and their insights provide guidance for the development of theory as well as for professional investment practice. Although we do not yet fully
understand how asset prices are determined, the research of the Laureates has revealed a number of important regularities that are helping us to arrive at better explanations.

I mean it is one thing to say these guys have helped us understand financial markets better but altogether a different thing to say their work helps predict asset prices. Even over a long term. If one has to give the prize for figuring asset prices for a long term, the award should perhaps go to Warren Buffet who did not follow either Fama or Shiller (Hansen was too mathematical for Buffet). He just followed the golden rules of investing which is to buy good quality managed companies and hold them really long.

Shiller in voxeu interview says:

When you think of finance, you come to it thinking “Make money! Get rich!” You should instead think about financing activities, things that people do together that are important to them. Achieving goals that are shared by groups of people. Financing activities is what it’s all about. And the underlying problem is that just about anything that we think is important to do can’t be done by one person. You need groups of people and you need resources, various things that are produced in other countries that would be inputs to your activities. And the organisation generally has to last for years and years to achieve the goal, so it has to have some kind of continuity of support from people and resources. And that support is called financing, so that’s what it’s all about.

So I was sort of puzzled by the choice of words used by the committee.

  • If anything based on Prof Fama’s work on EMH we just cannot predict anything.  All the info is there in today’s price and it is just useless to predict things. So, Just buy index funds and hopefully their prices will rise as economies and companies grow. And if you have a crisis like the recent one many years of wealth is likely to be wiped out.
  • Shiller was in the opposite camp who believed markets are anything but efficient. He believed in nuts and bolts of finance (transfer from surplus to deficit units, as shown in the above quote) and criticized much of the finance we see today.

Some have said the prize reaffirms the faith in markets.  Again, if one follows any of these guys they actually show limits of financial markets especially in the current form.

Shiller recently argued why the best and brightest people go into least productive finance sector.

Then based on Prof Fama’s EMH we should not be having such a large fin sector at the first place. If people are making so much money via arbitrage either there is something wrong with EMH or markets are highly inefficient. This efficiency should be improving over time as so much effort is being made to make markets efficient. But we have only seen arb activities increasing.  Despite the crisis, things have become only bigger and worse in finance. Infact EMH should hardly lead to such a crisis. What we could have is minor corrections of asset prices…

Coming to the committee statement. If asset prices could indeed be predicted over a longer-term, how about asking the trio to show the way. Infact Fama/Shiller might say no way..Fama will say my EMH shows it is impossible to predict asset markets….Shiller would say irrational exuberance in markets will lead to a crisis soon so no point in investing..


One Response to “Can we predict asset prices even over a long-term?”

  1. Loknath Says:

    I liked the feudal lord, river and chain analogy in the referred link. well said.

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