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Nobel Laureates Fama And Shiller Duel OverBubbles
Nov 22 2013, 14:58by: Larry Swedroe,
When Professors Eugene Fama and Robert Shiller were each awarded
this year's Nobel Prize in Economics(along with Lars Hansen) for
their work on asset pricing models, the financial media immediately
began to focuson the different views the two have about
bubbles.
What's a bubble? Can we define it? Do we know one when we see
one? When asked these type questionsFama's response is that the
term drives him nuts. On the other hand, Shiller provides a very
long definition with achecklist which includes rapidly rising
prices, mass media coverage, and investors showing emotions, like
envyand regret, for failing to have participated. Why's there such
a difference in views? Hopefully the following willhelp you think
about the issue.
I think a good place to start is with the term " irrational
exuberance," which we might define as unsustainableinvestor
enthusiasm that drives asset prices up to levels that aren't
supported by fundamentals. The firstreference to the term is
believed to have been by Alan Greenspan, former chairman of the
Federal Reserve, ina December 1996 speech, "The Challenge of
Central Banking in a Democratic Society." In that talk,
Greenspanstated that low inflation reduces investor uncertainty,
lowers risk premiums, and implies higher stock marketreturns. At
the time the S&P 500 was at 744(SPY). It closed 1996 at 741.
With earnings of $40.63, the price-to-earnings (P/E) multiple was
18.2. Were we in a bubble? Remember, if you state something is a
bubble thatimplies that you expect stock prices to come crashing
down as the bubble bursts.
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