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Gaurav Choudhury, Hindustan Times
October 15, 2013
Who has won the Nobel Prize for economics in 2013? Three US-based economists — Eugene F Fama, Lars Peter Hansen and Robert J  Shiller — have won this year’s Nobel Prize for economics for their research that has helped understand price movements of assets in financial markets such as stocks and bonds, and prices used for index funds.

What are their specific areas of work?
According to the Royal Swedish Academy of Sciences, 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.

Why are determining asset prices important?
Remember the mortgage loan crisis in the US in 2008? The crisis was brought about by a competitive banking system as they resorted to sub-prime lending. Banks extended housing loans to many customers, who did not actually possess the requisite repayment ability. The resultant payments default triggered massive fall in banks’ and real estate incomes.http://www.hindustantimes.com/Images/Popup/2013/10/16_10_13-metro17b.jpg

What is sub-prime and what is its significance in asset price movements?
Sub-prime refers to a loan given to a borrower who does not qualify for a regular home loan, because of a poor credit record, low income and no job security. Banks in the US gave out many such loans in their zeal to keep ahead of their peers in the banking sector. The subsequent defaults coupled with high unemployment resulted in major loss of income across the economy. This demonstrates the importance of assets prices and the consequences it can have in our day-to-day lives. Investment banks were counting big on the real estate boom and hence had overexposed its investments into the real estate sector. As the property prices went bust, so did the optimism of Lehman’s prospect on those investments. The subprime crisis was a result of individual incentives and lack of accountability. As risk is spreading globally, its ripple effect might surface in the unlikeliest of places.

How are the work of this year’s Nobel Laureates for economics relevant in the context of the current global economic slowdown?
The Royal Swedish Academy of Sciences has said that economists’ research on the prices of stocks, bonds and other assets held out critical lessons for the contemporary world of finance and economics. It is not just professional portfolio investors who keep a keen on eye on asset price movements. The behaviour of asset prices is essential for most people. “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,” the Academy said. 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.