05 Oct 2013


Economist Robert Shiller was awarded the Nobel Prize this year, along with two other economists Eugene Fama and Lars Hansen for their empirical analysis of asset prices.

He has been teaching and researching at Yale University Department of Economics since 1982, and currently teaches graduate level macroeconomics and an undergraduate course on financial markets. I had the privilege of taking his macroeconomics class while at graduate school. His intellectual curiosity and dedication to students left a deep impression on me.

Professor Shiller is one of the pioneer researchers for behavioural finance, a field that emerged in the 1980s. In the 1960s and 1970s, academic research in empirical asset pricing was dominated by Fama's efficient markets hypothesis.

Then, the key idea was that stock prices always incorporate all available information about fundamental values. When irrational behaviours emerge in the market, smart money always eliminates them.

The strong version of the hypothesis thus holds that stock market prices do not deviate from their underlying fundamentals for long - such deviations are constantly and instantly corrected by those with more information. Consequently, no one can beat the market' on a sustained basis. Instead, stock market prices always followed a random walk'.

Although conceptually elegant, this efficient markets hypothesis was put to a severe test in the 1980s when anomalies of the stock price movements could not be explained by its tenets.


In his seminal paper, Do stock prices move too much to be justified by subsequent changes in dividends?, Professor Shiller demonstrates that there was excessive volatility in stock market prices by comparing them with the present values implied by the efficient markets model. Such high volatility could not be reconciled with the theory unless one assumed improbably that the coefficient of risk aversion was extremely high. These contradictory findings generated significant controversies in asset-pricing research and finally led to, as Professor Shiller puts it, the blossoming of behavioural finance, in the 1990s.

Along the way, Professor Shiller created two important databases to facilitate research in behavioural finance. One of them was the Stock Market Confidence Index, which is currently maintained by the International Center for Finance at Yale School of Management. This quarterly survey, started in 1984, provides the longest time series data on US investors’ attitudes and confidence.

One of the major findings derived from the time series is that investor confidence increased significantly between 1989 and 2000. Professor Shiller described that phenomenon as “a proliferation of wishful-thinking theories about a new era that would propel the stock market on a course that, while uneven, is relentlessly upward”.

The other highly-cited database is the Case-Shiller Housing Price Index. This index, now published regularly by Standard and Poor’s, covers housing prices of more than 20 cities and has become one of the most important measures of housing values across the US.

In addition to academic research, Professor Shiller also became a household name for his bestseller books, Irrational Exuberance and Animal Spirits. Both books were timely. Irrational Exuberance correctly anticipated the bursting of the dot.com bubble. Animal Spirits (which Professor Shiller co-wrote with Nobel laureate, George Akerlof) was one of the first books written in the immediate aftermath of the 2008 global financial crisis which explained the crisis in terms of people’s beliefs and how the ‘stories’ of our times can drive market prices.

In these popular writings, he manages to convey complicated ideas of behavioural finance in a highly accessible way. They extended the often very technical financial research to beyond ivory towers of academia, and have benefitted many individual and institutional investors.

Yvonne Chen is an Assistant Professor at LKYSPP. Her areas of research include health economics, applied econometrics and development economics