Battling it out over how markets work

The awarding of this year's Nobel Prize for economics is a recognition of our lack of understanding.

Giving the Nobel Prize in economics to both Professor Eugene Fama and Professor Robert Shiller is like "awarding the physics prize jointly to Ptolemy for his theory that the Earth is the centre of the universe and to Copernicus for showing it is not", says John Kay in the Financial Times.

This is not as bad as it might sound if only because it shows clearly that there are no such certainties in economics.

Fama is one of the fathers of efficient market theory, which holds that the prices of stocks and bonds are rational' because they reflect all available public knowledge at any one time.

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Shiller, on the other hand, made his name by pointing out the "persistent irrationality" in markets, which are often driven by emotion.

The two men shared the award with Lars Peter Hansen, who developed a method of statistical analysis to evaluate theories about price movements.

The idea of efficient markets has "taken a pounding" over recent years, but Fama deserves the award, says Tim Harford in the Financial Times.

His ideas teach us that there's no such thing as an obvious bargain, and have helped popularise low-cost, diversified investments. After all, why pay fund managers huge fees to pick good stocks and time the market if the market is essentially priced correctly' most of the time?

If more investors had listened to Fama, they'd have been "suspicious" of allegedly safe sub-prime assets that somehow yielded high returns.

Yet it was Shiller, with his warnings of investors' "irrational exuberance" inflating asset bubbles who predicted the property crash of 2007, and the dotcom bust of 2000, says Ambrose Evans-Pritchard in The Daily Telegraph.

His Shiller price/earnings ratio, "which smooths earnings over a ten-year period to capture lasting value in equities", is followed by investors worldwide.

The dispute has had other far-reaching effects, says Binyamin Applebaum in The New York Times.

The deregulation of markets from the 1980s was justified by the view that markets are rational and efficient. Instead of ringing alarm bells, it led to complacency about rising property prices in the 2000s.

More recently, the work of Shiller and other behavioural economists has "been influential in shaping an intensification of financial regulation".

In jointly honouring their work, the committee has "highlighted how far the economics profession remains from agreeing on the answer to a basic and consequential question: How do markets work?'".