Learn lessons of Nobel laureates

Eugene Fama and Robert Shiller might not be household names, even among financial advisers, but they should be. They were among the three economists awarded the Nobel Prize in Economic Sciences last week for their analysis of asset prices. Mr. Fama most famously elucidated and championed the theory that financial markets are efficient and stock price movements are unpredictable. As such, active money managers theoretically can't outperform indexes. Mr. Fama's work has underpinned the growth of passive investing generally and index investing specifically. According to Bloomberg News, at the end of last year, passive investments between exchange-traded funds and mutual funds had more than $2.6 trillion in assets. Mr. Shiller, on the other hand, espouses a somewhat opposing view. A behavioral economist, he believes that markets are largely driven by human psychology, not information, and as such, large mispricings aren't necessarily uncommon and shouldn't be surprising. Mr. Shiller's thinking led him to predict the dot-com bubble in technology stocks. More recently, in 2005, he warned that housing prices were reaching irrationally exuberant levels. We all know how that turned out. The third recipient was Lars Peter Hansen, who developed a widely-used method of statistical analysis to test other theories of pricing movements. “The laureates have laid the foundation for the current understanding of asset prices,” the Royal Swedish Academy of Sciences said in its statement announcing the winners. These aren't ivory tower hypotheses that economists banter about but real-life theories that have been observed in the markets. And they continue to drive debate among other economists, portfolio managers and market strategists. As such, advisers should be familiar with the works of the Nobel laureates, at least those of Mr. Fama and Mr. Shiller, because it is likely that the research that won them the Nobel Prize directly influences some, if not all, of the investment products and strategies advisers use.