Robert Shiller, Eugene Fama Nobel Prize Undercuts Wall Street Science
Shiller's work, in contrast, challenges much of the efficiency in markets that Fama attempted to prove through his career.
In one paper, Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?, Shiller argued that if stock markets were truly rational, investors would value stocks on their expected future dividends at a present value discount. However, his study of stock market performance from the 1920s through the 1980s indicated that stock markets were far more volatile than what could be explained through changing expectations of future dividend payments. Put simply, markets acted on fluctuations in investors' irrationality, or over-and-under exuberance.
Shiller published Irrational Exuberance in 2000, near the peak of the Nasdaq bubble to make a clarion call that stocks were overvalued and Wall Street animal spirits had become disconnected from underlying financial performance. In the mid-2000s, Shiller famously applied his findings to the U.S. housing market. He argued that home prices had risen far faster than the inflation rate and were consequently overvalued.
While much of Fama and Shiller's work directly contradicts each other, as noted in Shiller's own writings, the studies of both laureates challenge much of Wall Street's so-called applied science.Corporate and portfolio valuations are far less stable than M&A models and analyst valuations may indicate. Hedge funds advertising some type of absolute return are likely to be overstating their ability to find value, and may be reliant upon flaws in commonly used formulas. Stock market prices, merger valuations and the like are also not simply a matter of changes in underlying value, but also are attributable to Animal Spirits, which often run too far on the spectrum of greed or fear. No matter how carefully prepared today's batch of Excel models and PowerPoint presentations are, Wall Street is just as much an art as it is a science. -- Written by Antoine Gara in New York Follow @antoinegara
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