The odds favorite to win the Nobel, Eugene Fama, lost the prize to two other Americans, Elinor Ostrom and Oliver Williamson.

Ostrom & Williamson study the way decisions are made outside of markets, which is the focus of many other economists.

This award is a victory, in small part, for the Behaviorists, whose studies of our flawed wetware include such normal human foibles as irrationality, poor decision making, biases, non profit maximizing behavior.

Why? As we noted last night, the odds on favorite to win was the precise opposite of the behavioral economists — the father of the efficient market hypothesis, Eugene Fama. Users of his EMH have created various predictions markets. These markets had Fama  the odds on 2 to 1 favorite to win the prize this year. There is no small degree of  irony here, in that Fama’s Efficient Market Hypothesis, where markets reflect all information on a given event, had so much wildly misplaced optimism on this occasion.

In a case of bizarre reflexivity, if these markets had  not been so bullish on Fama’s chances of winning, it would have done more to prove his theories. Instead, they gave him the best odds to win. This actually points to a major flaw in their thesis: the false belief that Humans make good decisions in groups, or that markets accurately depict the sum total of info on a given subject.

As I have argued in the past, prediction markets work best when their members mirror those of the group they are seeking to forecast. Jurors, Boards of Directors, Nobel Prize committees all are terrible groups for these markets to forecast, as their members rarely have much in common with prediction market Traders.

Perhaps the greatest irony is that Fama supporters, whose theories do such a poor job explaining bubbles and busts, were surprised by the results. Given the failure of the market itself to anticipate its own collapse, perhaps this was a very poor year to expect much in the way of recognition of the theories that supported many of the decisions that led to the collapse.

EMH proponents are apparently as tone deaf politically as they are economically.

>

Previously:
Presidential Futures Markets: Spurious Predictive Powers (October 6th, 2004)

http://www.ritholtz.com/blog/2004/10/presidential-futures-markets-spurious-predictive-powers/

A Few Words on Prediction Markets (May 26th, 2005)

http://www.ritholtz.com/blog/2005/05/a-few-words-on-prediction-markets/

Confusing Cause & Effect: Elections and Markets (January 9th, 2008)

http://www.ritholtz.com/blog/2008/01/confusing-cause-effect-elections-and-markets/

Category: Markets, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

27 Responses to “Ostrom & Williamson Win “Ironic” Nobel in Economics”

  1. basquebob says:

    Barry, this kind of comments is why I love reading your blog.

  2. cvienne says:

    Well,

    The “efficient market hypothesis” du jour seems to be that the dollar is going down forever…

    It’s not only going to zero, but below zero, way below even absolute zero…

    So seeing this, those “clever & efficient” people in the market keep bidding the process along… Meanwhile, overbidding prices on US equities & commodities based on the phenomenon…

    In the end, as the dollar vaporizes before our eyes, that huge sea of capital (called bonds) appears to be the RISKIEST investment on the planet…

    Now that’s what I call EFFICIENCY!

  3. constantnormal says:

    Kinda interesting how the falsity of the “efficient markets” notion conflicts with the truthiness of the “wisdom of the crowd” notion (which has been verified experimentally).

    Perhaps there is a fundamental difference between how crowds assess things when their own well-being is not at stake.

    Or perhaps it is that the experiments documenting the “wisdom of the crowd” do not involve predicting the future, and instead uses an averaging of perceptions of an existing situation rather than an average of expectations for the future.

    ~~~

    BR: The distinction is that crowds are right much of the time, but when they are wrong (think market tops and bottoms) they totally shit the bed!

  4. Andy T says:

    Love seeing these kinds of fellows receiving some official recognition. Behaviorial Economics Rocks!

  5. Phil Izzo says:

    Both of the laureates were focused on nonmarket institutions. The committee said that the decision wasn’t influenced by the financial crisis, but it’s hard to look at the research and not see some connection to concerns raised by the Great Recession.

  6. ronald says:

    I think the problem with “efficient markets” is the irrational believe they are dealing with information in the first place.
    For a brain it goes like this (simplified version)

    Information = Data in context
    Context = Organized data
    Learning = Self organization of data (builds context)

    In other words all Information is “local” there is something like shared context, based on education and cultural environment for example, but in general information is personal.
    Now Groups of people in general are good in finding problems in any theory, since as more context you have as easier it is to identify problems. The scientific process works that way, but requires some good education to provide the exact context to any given theory to see if it’s correct and then some.
    But if you put a lot of none experts, no precise context, together. They will convince themselves of mostly anything, since they have no clue in context what will not work. So may I suggest better education of these People?

    One problem with all of this exists, gifted people. They can “see” past why something should not work, actually it’s more like they don’t see the problems and later wonder why something works like they said it would. Problem is, most People who think they are gifted are not.

  7. It looks like the committee finally picked economists who could explain why the committee picked them

  8. The crowd sets the price. Sometimes they forget that they are also the buyer

    you should see them haggle :)

  9. M.G. in Progress says:

    My post at http://mgiannini.blogspot.com/2009/10/nobel-prize-in-economic-sciences.html was a bit more ironic on economists, their theories and predictions…Do we need them?

  10. dblwyo says:

    Actually Williamson and Ostrom work in the “new institutional economics” which says essentially that the pure theory of markets ignores the factors, like rule of law, property rights, court systems, police, etc. that actually lead to the existence of markets. Several years ago the Nobel was awarded to Doug North and Bob Fogel for their study of the rise of institutions and the role of those institutions in promoting market efficiency and effectiveness. This is much more than a mere quibble as it’s really an existence proof for all that EMH holds dear and which is not a historic accident but the result of millenia of careful nurturing. Another guy who should have won is Mancur Olson but his personality was such nobody wanted to award it to him and he passed on too young for time to force the issue.

  11. MRegan says:

    Interesting item on the dollar.

    http://www.bloomberg.com/apps/news?pid=20602081&sid=a4x9dIJsPn4U

    As far as efficient markets go, an efficient market would likely produce stasis. I for one am glad markets aren’t efficient.

  12. Dan Duncan says:

    A silly post.

    Ladbrokes established the initial line through its own oddsmakers–not through a market mechanism. The line might have moved if enough people took the action…which I sincerely doubt.

    [BR: Then why didn't the traders move the needle? What of all the other online prediction sites?]

    When you write: “In a case of bizarre reflexivity, if these markets had not been so bullish on Fama’s chances of winning, it would have done more to prove his theories.” Such a statement only makes sense in an environment when hundreds or thousands of people are placing bets at Ladbrokes on the Nobel Prize for Economics. An absurd assumption.

    I do wonder, however, what insights the behavioral economists have on those who make who create a straw marketplace in order to draw unwarranted conclusions about the straw transactions from within that market.

    Case in Point on the Ladbrokes Market for these cultural/social novelty bets: Currently Ladbrokes is taking bets on whether or not there will be a televised live debate between the 3 main UK party leaders before the next election. The odds are 4 to 7 that they will televise. As scintillating as this appears, I still imagine it generated more interest than whether Jean Tirole is a good bet to win the Nobel at 9/1. And what is the action on this “market”? There are 2 outstanding bets at Ladbrokes.

    So…if they don’t televise…What then? “The market participants cannot even anticipate the televised debate. Clearly EMH is wrong!” Ridiculous.

    In fact, if you are going to draw conclusion about EMH from betting markets…do a little research before opining: You’ll find that Casino lines on heavily wagered sports are, in fact, VERY strongly supportive of an efficient market.

    And finally…for those interested:

    4/7 on televising the debate! Is Ladbrokes out of its mind?! The BBC will step up. Put your $$ on televising. It’s a stone cold lock!

  13. MRegan says:

    Interesting item on the dollar:

    http://www.bloomberg.com/apps/news?pid=20602081&sid=a4x9dIJsPn4U

    As far as efficient markets, an efficient market would likely produce stasis. I for one am glad markets are inefficient.

  14. [...] all information on a given event, had so much wildly misplaced optimism on this occasion.” – Barry Ritholtz, chief executive of Fusion IQ, an online quantitative research [...]

  15. Reactions to the Nobel Prize in Economics

    Two social scientists, Oliver E. Williamson and Elinor Ostrom, won the Nobel Memorial Prize in Economic Science on Monday. Mr. Williamson won for his theory of why some business transactions take place inside of firms and others don’t; and Ms. Ostrom won for her analysis of the rules and procedures that govern common property ownership.

    Here is how economists and other pundits reacted to the news:

    ~~~

    “Economics has been too isolated and these awards today are a sign of the greater enlightenment going around. We were too stuck on efficient markets and it was derailing our thinking.” - Robert Shiller, professor of economics, Yale University.

    ~~~

    “Apart from issuing my now-annual October lament that Armen Alchian and Gordon Tullock still do not have Nobel Prizes, I applaud this year’s selection of Elinor Ostrom and Oliver Williamson. Williamson’s 1985 book The Economic Institutions of Capitalism remains a classic that repays careful study, even in 2009. And Ostrom’s work on how people often solve public-goods problems voluntarily is too often overlooked — until today, that is!” - Don Boudreaux, professor of economics, George Mason University.

    ~~~

    “The way to think about this prize is that it’s an award for institutional economics, or maybe more specifically New Institutional Economics. Oliver Williamson’s work underlies a tremendous amount of modern economic thinking; I know it because of the attempts to model multinational corporations, almost all of which rely to some degree on his ideas. I wasn’t familiar with Ostrom’s work, but even a quick scan shows why she shared the prize: if the goal is to understand the creation of economic institutions, it’s crucial to be aware that there is more variety in institutions, a wider range of strategies that work, than simply the binary divide between individuals and firms.” - Paul Krugman, professor of economics at Princeton University and last year’s recipient of this prize.

    ~~~

    “[T]he short answer is that the economics profession is going to hate the prize going to Ostrom even more than Republicans hated the Peace prize going to Obama. Economists want this to be an economists’ prize (after all, economists are self-interested). This award demonstrates, in a way that no previous prize has, that the prize is moving toward a Nobel in Social Science, not a Nobel in economics. I don’t mean to imply this is necessarily a bad thing — economists certainly do not have a monopoly on talent within the social sciences — just that it will be unpopular among my peers.” - Steven D. Levitt, professor of economics, the University of Chicago.

    ~~~

    “This award is a victory, in small part, for the Behaviorists, whose studies of our flawed wetware include such normal human foibles as irrationality, poor decision making, biases, non profit maximizing behavior. Why? As we noted last night, the odds on favorite to win was the precise opposite of the behavioral economists — the father of the efficient market hypothesis, Eugene Fama. Users of his EMH have created various predictions markets. These markets had Fama the odds on 2 to 1 favorite to win the prize this year. There is no small degree of irony here, in that Fama’s Efficient Market Hypothesis, where markets reflect all information on a given event, had so much wildly misplaced optimism on this occasion.” - Barry Ritholtz, chief executive of Fusion IQ, an online quantitative research firm.

  16. M.G. in Progress says:

    Ok, economists cannot even predict their own prizes and they cannot agree on the validity of their theories. The odds for both winners were 50/1 so we are in a classic case of Black Swan Theory, more black than the award to Obama…

  17. VennData says:

    Another political Nobel.

    A total slap in the face to the sexist Director of the White House’s National Economic Council, Larry Summers. What has this so-called female Nobel laureate done? Nothing (nothing with markets anyway.)

    This is simple man-bashing from the Nordic kings… er… a… queens of sex quotas.

    There will never be another penal-afflicted-person Nobel in our lifetime. Sad. Thanks Liberals.

  18. [...] Ostrom & Williamson study the way decisions are made outside of markets, which is the focus of many other economists. This award is a victory, in small part, for the Behaviorists, whose studies of our flawed wetware include such normal human foibles as irrationality, poor decision making, biases, non profit maximizing behavior. –Barry Ritholtz, Fusion IQ [...]

  19. Bruce in Tn says:

    http://www.marketwatch.com/story/obama-fails-to-win-nobel-prize-in-economics-2009-10-12

    Obama fails to win Nobel prize in economics

    “LONDON (MarketWatch) — In a decision as shocking as Friday’s surprise peace prize win, President Obama failed to win the Nobel Memorial Prize in Economic Sciences Monday.”…….

    …Ah, yes, it appears Leftback has now started working at Marketwatch. This man, Tom Bemis, he’s the kind of snarkist of the Obaminable Showman after my own heart…

    Sarcasm rules!

  20. dark1p says:

    Barry, this post is a classic. Excellent take down! And so deserved.

  21. joeydee61 says:

    You’re all wet.

    Nowhere does the EMH claim that markets perfectly predict future events, let alone the decisions of a five-man committee with a leftist political agenda. To the contrary, surprise outcomes (and for that matter, volatility, precipitous price increases, and declines) are central predictions of market efficiency. Predictability, if it existed, would be a violation of market efficiency.

    Yet whenever something unexpected happens—or even when markets go down—people accuse the EMH of “misleading” us. This is convenient for Behaviorists, but also for Statists who want to villainize capitalism. After all, if markets don’t work and consistently misallocate resources, the idea of a philosopher king ruling the economy begins to make sense. But markets DO work; the evidence is all around us that capitalism allocates resources very well. This couldn’t happen if prices were constantly “wrong.”

    The betting market rationally favored Fama because he’s an obvious and overdue choice. The only thing this says about an efficient market is that it has better judgment than a handful of Swedish market-hating socialists and their blogging buddies.

    ~~~

    BR: It doesn’t have to be perfect — but you must admit that markets have been, on a frequent basis, wildly, incorrigibly, specatacularly wrong!

  22. [...] it isn’t, and I’d like to give a special Alanis Morissette award to anybody who thinks it is. (Barry Ritholtz and Dan Gross, I’m looking at you. And you too, [...]

    ~~~

    BR: As I noted in the page on odds, he had the BEST odds to win of all economists.

    That made him the favorite . . .

  23. Goldilocksisableachblond says:

    “Economics has been too isolated…….” – Robert Shiller , professor of economics, Yale University.

    A massive understatement. The economic gene pool is in desperate need of non-familial inputs , as this graphic illustrates :

    http://well-formed.eigenfactor.org/radial.html

    ( It takes a few seconds to load. ‘ Economics’ is at about 1 o’clock on the circle. )

  24. NEITHER Oliver Williamson of the University of California at Berkeley nor Elinor Ostrom of Indiana University at Bloomington was widely tipped to win this year’s Nobel prize for economics. This may be because their work sits at the boundary of economics, law and political science, and tackles different questions to the ones that economists have traditionally studied. Ms Ostrom is also notable as the first woman to win the economics prize in its 40-year history.

    Mr Williamson and Ms Ostrom work independently of each other but both have contributed plenty to economists’ understanding of which institutions—firms, markets, governments, or informal systems of social norms, for example—are best suited for conducting different types of economic transactions. Why, for example, do some transactions take place within firms, while others are carried out in competitive markets?

    Ronald Coase, a British economist who won the Nobel prize in 1991, argued that in some situations, and for some kinds of transactions, administrative decision-making within a single legal entity (ie, a company) is more efficient than a straightforward market transaction. Mr Coase’s arguments were influential and convinced economists that the internal workings of organisations were worth paying attention to explicitly. But it was left to Mr Williamson to refine Mr Coase’s theory and clarify what features of certain transactions made carrying them out more efficient within a firm rather than in the market.

    Mr Williamson showed that complex transactions involving investment decisions that are much more valuable within a relationship than to a third party are best done within a firm. Part of the problem, he argued, was that some economic transactions are so complicated, and involve so many things which could go wrong, that writing a legally enforceable contract that takes all possibilities into account is impossible. Simpler transactions are completed easily in markets; more complicated ones may demand firms. But in later work he also showed that organising matters within companies had costs: in particular, it relied on internal authority to get things done, and this could be abused.

    Ms Ostrom has concentrated on a different aspect of economic governance. She has spent her life studying how human societies manage common resources such as forests, rivers, pastures or wildlife. Just as with public goods, it is difficult to prevent people from using the commons. But unlike public goods, and like private ones, what one person takes leaves less for others. Economic theory then predicts that rational individuals will overuse these resources.

    Economists (including Mr Coase) have tended to emphasise property rights as a solution to the problem of managing common resources. Typically that involves either privatisation or putting the resource in government hands. But Ms Ostrom, who is a political scientist by training, spent much of her early career studying how communities managed such common resources. She found that groups of people tended to have complex sets of rules, norms and penalties to ensure that such resources were used sustainably. Such self-governance often worked well.

    Successful informal institutions, she found, have certain features in common, which sets them apart from institutions that fail. The principles of game theory, particularly the theory of repeated interactions, proved remarkably useful in formulating general principles of how common resources ought to be managed without necessarily resorting to private or state ownership.

    Mr Williamson launched an entire branch of economic theorising which looks more deeply into firms than economists had tended to do previously. His theories have also helped with understanding the choice between equity and debt, and corporate finance more generally. Ms Ostrom’s research has spawned many experiments about how people interact strategically. Some of these have influenced game theory, which originally provided Ms Ostrom with her analytical tools.

    The Nobel committee’s decision, like earlier awards to Amartya Sen and Daniel Kahneman, is a welcome shot in the arm for research that crosses disciplinary boundaries in the social sciences.

  25. Stephen says:

    The last few years have shown that economics, and most economists are a joke. The last few weeks have shown that the Nobel committees are a joke. I don’t know what joke-squared amounts to, but I’m sure that I don’t care much.

    Barry, you seem to not like the ‘efficient market’ characterization. I don’t care personally at all about the efficiency being good or not, I’m sure that if somebody stuck a gun in my face and told me to be more efficient I probably would work harder. What I care about is freedom and liberty and that is what a ‘free’ market is. If I decide to spend the day fishing, somebody will say that I’ve made a bad or irrational decision because my family needs me to work, work, work or they might not get to go on that vacation to the lake.

    This behavior based crap is just another justification for some beurocrat to tell me how to spend my days and which way to wipe … ‘for the good of the many’ I suppose. If I manage to lay a golden egg in my sleep and decide to use it for a paperweight, there will be some creep pounding on the door telling me that I’m inefficient because I didn’t invest that egg in some market somewhere and that justifies the egg being stolen from me … ‘for the good of the many’.

    Anyway … I don’t need the current fassionable trend in economics to tell me what to do with my stuff. Live and let live – a lost concept.

  26. johnny says:

    your theory has a lot of merit. in which case you could have profit handsomely by sell the favorite in the case.

  27. rh_heath says:

    “BR: It doesn’t have to be perfect — but you must admit that markets have been, on a frequent basis, wildly, incorrigibly, specatacularly wrong!”

    Sorry, but this doesn’t cut it as a refutation of EMH. What you need to show is that markets have been wildly, incorrigibly, spectacularly and PREDICTABLY wrong.

    How much did you make betting against Fama at Ladbrokes?