Shiller Proved Markets Can Go Crazy

Markets are irrational. That short phrase sums up the most important findings from the long career of Nobel Prize-winning economist Robert Shiller.

I was always sceptical about rationality of human behaviour. Basically, these markets can go crazy sometimes. That was my view and it coloured the kind of work that I did.
— Robert Shiller

Shiller's biggest target through the years has been the efficient market hypothesis, which holds that markets are perfectly rational and self-correcting based on the latest available information.

In 1965, Eugene Fama argued that stock prices already reflect all known information. When new information arrives, prices move—but since news can’t be predicted, neither can price changes. (See his paper, “Random Walks in Stock Market Prices.")

But Shiller showed that stock prices fluctuate far more than underlying fundamentals would justify if markets were truly efficient. His work on “excess volatility” and later on “irrational exuberance” demonstrated that psychological factors, herd behavior, and bubbles play a massive role in financial markets.

As a result of Shiller's work, most serious economists now see markets as partially efficient but prone to behavioral distortions. This is the middle ground Shiller helped carve out.

For more from Shiller, read his latest book, Narrative Economics: How Stories Go Viral and Drive Major Economic Events. The Financial Times named it one of the best books of the year in 2019.

Also check out the earlier My Daily Oracle story, "Which scares you more, bears or bulls?"

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