Of Nobel Prizes and Ignoble Disguises

“The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2013 was awarded jointly to Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller for their empirical analysis of asset prices” read my friend Swami from his iPad, as we were having our weekend coffee after a long time.

Looking up from his iPad at my broker friend Jigneshbhai, he asked, “What is empirical analysis of asset prices?”

“Well, they studied how stock prices move and what were the reasons for it” replied Jigneshbhai, nonchalant as usual, while sipping his coffee.NobelPrize

“So what did they find?” Swami’s curiosity was aroused.

Jigneshbhai explained, “Fama found that markets are efficient and it is not possible to predict stock prices in the short-term and benefit from it. He is known as the father of the efficient market theory.”

“And what about the others?” asked Swami.

My broker friend continued, “Shiller found that markets are inefficient and it is not possible to predict stock prices in the short-term and benefit from it. He is known as the father of behavioural economics.”

That confused Swami. “How is that possible? These are two opposite views, they are saying different things, isn’t it? And both got the Nobel prize?”

I also started wondering whether my broker friend had got anything wrong.

Jigneshbhai smiled and decided to explain. “Yes, they are opposite views, but with the same conclusion.”

“Fama said that markets fully price stocks rationally, and whenever any news comes in, that gets fully factored into prices quickly. As you cannot predict news in the short-term, you cannot predict stock prices.”

“Shiller said that fluctuations in prices cannot be explained by changes in rational things like dividend. So human behaviour and emotions dictate stock prices, and often create asset bubbles. As you cannot predict human emotions in the short-term, you cannot predict stock prices.”

“Both of them agree though that it is possible to predict a broad course of stock prices over the long-term.”

Swami and I tried to absorb the explanation. It seemed like both of them were right. But as we were still thinking, Jigneshbhai further explained.

“Basically whether markets are efficient or behavioural, the conclusion is you can’t predict stock prices in the short-term, but can, perhaps, make a guesstimate of their broad course over long-term.”

Swami and I seemed to be getting it now. What Jigneshbhai had simplistically explained to be the findings of the Nobel Laureates also reflected what Swami had read in some ‘guru‘ books. Ignore short-term movements, Forget individual stocks, Buy broad-based index funds for the long-term.

But it did not seem to align with what the financial media and financial services industry seemed to be doing every day.

“But if you cannot profit from predicting stock prices everyday, what are CNBC and the rest doing everyday?” asked a perplexed Swami.

Jigneshbhai silently smiled and continued sipping his coffee.

“They seem to be predicting news, predicting sentiment everyday! They seem to be giving advice that does not seem in line with the Nobel Prize?” an agitated Swami continued.

Jigneshbhai almost neglected the question, finished his coffee, and cleared the bill.

Just then, as we were getting ready to leave, I saw the wealthy man in the sprawling bungalow who always talks cryptically. He had been listening to our conversation from the next table since the past few minutes and walked up to Swami.

“That’s not advice. Most of what you see is an ignoble disguise. Neglect them and go with the Nobel Prize” he said as he walked away.

2 Responses to Of Nobel Prizes and Ignoble Disguises

  1. Prashant Sant says:

    Nice distillation of prevailing investment philosophies Ranjit. Keep up the good work.

  2. Ranjit Kulkarni says:

    thanks Prashant – good to know you liked it!

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