The Nobel Prize is perhaps the most globally recognized honor in each of the fields in which it is presented. To find out what a challenge it is to obtain, you can go to the official web site, or keep reading! The Nobel Internet archive is also a great resource.
Each year the category committees send individual proposals to thousands of scientists, members of academies, and university professors in numerous countries, asking them to nominate Nobel Prize candidates for the coming year. Those considered competent by these committees to submit nominations are chosen in such a way that as many countries and universities as possible will be represented.
The process is very rigorous. Nominations received by each committee are then evaluated with the help of specially appointed experts. When the committees have made their selection among the nominated candidates and have presented their recommendations to the prize-awarding institutions, a vote is taken for the final choice of Laureates.
The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel is awarded at the Prize Awarding Ceremony at the Concert Hall in Stockholm, Sweden, on every December 10th, the anniversary of Alfred Nobel's death.2.2.2twenty-six of today’s sixty-nine Nobel Laureates in Economics attended or taught at the University. This is an impressive thirty-eight percent of all Nobel Laureates in Economic Sciences. As of 2011, The University of Chicago list for Nobel Prizes in Economic Sciences includes: Thomas J. Sargent, 2011, Roger B. Myerson, 2007, Leonid Hurwicz, 2007, Edward C. Prescott, 2004, James J. Heckman, 2000, Daniel L. McFadden, 2000, Robert A. Mundell, 1999, Myron S. Scholes, 1997, Robert E. Lucas Jr., 1995, Robert W. Fogel, 1993, Gary S. Becker, 1992, Ronald H. Coase, 1991, Merton H. Miller, 1990, Harry M. Markowitz, 1990, Trygve Haavelmo, 1989, James M. Buchanan Jr., 1986, Gerard Debreu, 1983, George J. Stigler, 1982, Lawrence R. Klein, 1980, Theodore W. Schultz, 1979, Herbert A. Simon, 1978, Milton Friedman, 1976, Tjalling C. Koopmans, 1975, Friedrich August von Hayek, 1974, Kenneth J. Arrow, 1972, and Paul A. Samuelson, 1970.
The Univac 1 System #42, delivered to the Univ. of Chicago in Nov. 1957 as used by CRSP to assemble the data.
Why is the University
of Chicago so obviously prominent? In 1959, Louis Engel, vice president
at the firm then known as Merrill Lynch, Pierce, Fenner & Smith made
a phone call. He asked Professor James H. Lorie whether anyone knew how
well most people performed in the stock market relative to other investments.
Unable to answer the question, Lorie was intrigued. He proposed that Merrill
Lynch fund a project with the purpose of gathering, cleaning, and completing
the prices, dividends, and rates of return of all stocks listed on the
NYSE. Lorie would utilize the new capabilities offered by computers in
developing a database to maintain accurate securities information over
time. With a complete and accurate database, researchers would no longer
need to compile their own data. The project would prove invaluable to
CRSP is an acronym for the Center for Research in Security Prices, which is located at the University of Chicago. Established in 1960 with a $300,000 grant from Merrill Lynch & Co., CRSP undertook the massive data-gathering project. From 1964 to 1986, the Center received gifts in excess of $1 million from those who yearned for the answer as much as they did. James Lorie became the center's first director, a position he held until 1975. He and Lawrence Fisher, former Associate Professor of Finance and Associate Director of CRSP, collaborated to gather the data. The two colleagues were faced with the monumental responsibility of researching the accuracy of each piece of stock information. They made use of their own formidable training and experience to fill in the blanks for missing stock prices.
The most significant problem investors have is their reliance on factors other than empirical research to select their investments. Investors are mostly speculating and relying on Lady Luck rather than Nobel Laureates. They are most often chasing the recent success of a manager, stock, time, or investment style.2.3.2
The great majority
of investors are unaware of the tremendous amount of academic brainpower
that has been applied to investing. This lack of awareness makes investors
more susceptible to the lure of active management, engaging in risks they
do not understand.
There is a stark contrast between a peer reviewed non-biased academic paper and an article in The Wall Street Journal, Barrons, Forbes, Fortune, Money, an analyst report, or the numerous other sources of investment research. Virtually every private investor is unaware of the vast amount ofacademic research that points to investing in portfolios of index funds.
The solution to the void of investor information is to take a quick walk down the timeline of modern finance. Beginning nearly 350 years ago, I hope this story will lead recovering active investors to a more sound investing strategy--a diversified portfolio of index funds.2.4.1
is built on the pillars of academic research, some of which have led to Nobel
Prizes. The following milestones demonstrate how strongly the creativity,
determination, and tireless research of thousands of individuals influenced
the development of the 12-Step Program to Index Funds.
Modern finance began with the realization that risk needed to be measured and managed. "The intelligent management of risk" can be traced to 1654 during the Renaissance Period. This was a time of great discovery. Centuries-old beliefs were constantly under question and reevaluation. This time of rebirth challenged wizards, mystics, fortune-tellers, oracles, and soothsayers, who were previously regarded as experts on predicting the future. One day in 1654, a French gambler named Chevalier de Mere and a mathematician named Blaise Pascal tried to predict the future outcome of a game of chance.
They wanted to determine how to divide up the stakes of an unfinished game, when one player was slightly ahead. With input from Pierre de Fermat, they developed the theory of probability. This theory is the basis for the concept of risk management and modern finance. Years later in 1952, Nobel Laureate Harry Markowitz embraced what a French gambler had questioned in 1654 and converted it into the theory of Portfolio Selection. His idea revolutionized the investment process! (Also see How Do We Measure Risk)
Halley, the famous English astronomer who discovered Halley's Comet, began
work on a series of life tables in early 1690. A probability based life
expectancy could be derived from these tables, which later became the
blueprint for the life insurance industry. Techniques of risk management
were improved over the years, leading to one of the first commercial applications
by the English government. Government officials developed life expectancy
tables and sold life annuities, soon followed by marine insurance products.
Halleys work ultimately led to the founding of Lloyd's of London,
which originated in a tiny English coffee shop that Halley frequented.
These same principles of managing risk were later applied to the stock
A critical element in the development of risk management was the discovery of standard deviation and the bell shaped curve by Abraham de Moivre in 1730. Francis Galton, cousin to Charles Darwin, proposed the Theory of Regression to the Mean by 1875. This theory predicts that a result will be closer to the "normal" or the expected average over time.
The Wealth of Nations
In his 1776 landmark book, The Wealth of Nations, Adam Smith asserted that capitalistic countries would prosper, while non-capitalistic countries would not. His argument was based upon the concept of the invisible hand, the idea that individuals who acted in their own self-interest would benefit society as a whole. By allowing supply and demand to dictate prices, a free market economy would ensure that resources are exchanged in the most efficient manner. Similarly, index fund investing is based on the idea that market prices adjust to reflect current market conditions, and that speculating on future prices is a losing endeavor.
Judge Samuel Putman
The Prudent Man Rule
In a case of alleged improper management of a trust account, Judge Samuel Putman presided with a decision that has become known as the Prudent Man Rule, still used today to establish proper guidelines for trustees. He stated, "Do what you will, the capital is at hazard. All that can be required of a trustee to invest is that he shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion, and intelligence manage their own affairs, considering the probable income, as well as the probable safety of the capital to be invested." This was one of the first authoritative and clear statements that risk has to be considered along with return.
The Beginnings of Random Walk Theory
The year 2000 marked the centennial of the Random Walk Theory of stock market prices. One hundred years since the theory's conception, the overwhleming majority of investors are still not convinced that the markets move in a random fashion. Many scholars confirmed and refined the research of Louis Bachelier, the hapless unsung hero of financial economics. He wrote "The Theory Of Speculation" in 1900 and presented it as his doctoral thesis to the faculty of the Academy of Paris. Bachelier anticipated much of what was later to become standard fare in financial theory: the random walk of financial market prices. "There is no useful information contained in historical price movements of securities."
As is typical with great minds, his professors and contemporaries did not appreciate his innovation. His thesis received humiliating marks from his professors, and he quickly dropped into the shadows of the academic underground. After a series of minor posts, he ended up teaching in an obscure French town for much of the rest of his life. His valuable work was largely ignored until the mid-1960s when now Nobel Laureate Paul Samuelson unearthed and elaborated on his findings.
MIT professor Paul Cootner published a 500-page collection of research reprints on the randomness of the market in 1964. The Random Character of Stock Market Prices contained the first full text English translation of Bachelier's 1900 thesis. Cootner delivered this accolade about Bachelier: "So outstanding is his work that we can say that the study of speculative prices has its moment of glory at its moment of its inception."
The Random Walk Theory describes the way stock prices change unpredictably as a result of unexpected information appearing in the market. This "random walk" of changing prices has created a misconception among investors that stock prices change randomly for no rational reason. It is not the changes in stock prices that are random, but the news that is random. News is inherently unpredictable, or it would not be considered news. In reacting rationally to new information, the stock prices look as though they behave in a random fashion. Many others, including Paul Samuelson and Eugene Fama, would later expand on Bacheliers work.
See these two informative articles (pdf format) on Bachelier: 1, 2.
Vox Populi (Voice of the People)
The English scientist Francis Galton, founder of the science of measuring mental faculties, discovered that the wisdom of the many is more accurate than the wisdom of a few. Galton arrived at this discovery in 1906 at a livestock convention where a crowd of about 800 was asked to guess the weight of an ox. Galton added up all of the guesses and calculated the average. The crowd had collectively guessed that the ox weighed 1,197 pounds, just a pound away from the actual weight of 1,198 pounds. While no one individual came as close to the actual weight, the collective crowd’s average estimate hit it almost spot on. From this, Galton concluded that a crowd of regular individuals making independent guesses based on their own independent experiences comes the closest to matching the performance of experts.
The world’s equity markets prove out Galton’s discovery. Millions of investors throughout the world contribute their independent estimates of a stock’s value, resulting in a price that is more accurate than any one individual’s guess. This is the primary reason why indexing works; the market’s price embodies the wisdom of the crowd as it reacts to the news about capitalism.
The Standard & Poor's 500 Index
1932, Alfred Cowles established the Cowles Commission for Research in
Economics with the motto, "Science is Measurement." He also
funded the Econometric
Society's journal, Econometrica. (see these great papers) The Commission moved
to the University of Chicago in 1939 and later to Yale University
in 1955, where it was renamed the Cowles Foundation. Almost every U.S.
winner of the Nobel Prize in Economics has spent time with the Cowles
In need of a measurement stick, Cowles created a market index in 1938, which became the basis for the 1957 introduction of the Standard & Poor's 500 Index. The goal was to establish a stock market index to represent the average experience of stock market investors. After sweeping failures in forecasting the 1929 crash, the prominent Colorado businessman and investment counselor wanted to focus his considerable statistical skills on analyzing stock market forecasters' ability to choose a portfolio that beats a market average or index.
Cowles reviewed approximately 12,000 recommendations and four years of transactions by twenty leading fire insurance companies and published his results in a July 1933 article titled, Can Stock Market Forecasters Forecast? His conclusion was, "It is doubtful." His extensive study of stock market data provided an early demonstration of the "random walk" in stock price movements and the beginning of the Efficient Market Hypothesis. Cowles published a follow-up study in 1944, reviewing 6,900 market forecasts over a period of 15.5 years. Once again, he concluded there was no evidence supporting the ability of the forecaster to predict the future of the market. His studies were the first of over 200 in the area of active manager performance measurements.
Cowles determined that despite his research and the research of countless others after him, investors would continue to listen to market forecasters, because they truly wish to believe that somebody, anybody, knows what the future will bring. Most people think that a world in which nobody has a clue is genuinely frightening.
The Cowles Commission in their original Colorado Springs office (more photos.) From left; Professor Gerhard Tintner, Dickson H. Leavens, Dr. Harold T. Davis, Herbert E. Jones, Alfred Cowles (photo courtesy of the Cowles Foundation)
The motto "Theory and Measurement" was first adopted in 1952. It succinctly captures the mission of the Cowles Foundation, which is the development and application of rigorous logical, mathematical, and statistical methods of analysis in economics and related fields. This motto replaced the original Cowles Commission original motto "Science is Measurement," reflecting the importance of theory that became clear early in the history of Cowles. Over the years Cowles scholars have made important contributions to economic theory, to econometric theory, and to a broad range of fields of economics through work that combines economic models with statistical methods of measurement. The mission of "theory and measurement" is reflected in the broad range of Cowles activities today, including those of its four core research programs in Econometrics, Economic Theory, Macroeconomics, and Structural Microeconomics.> Source: Cowles Foundation>
Harry Markowitz, (Also see The Harry Markowitz Page)>
Nobel Prize in Economic Sciences, 1990
bet the ranch.
Get more bang for your buck.
Maximize output relative to input.
Nothing ventured, nothing gained.
Diversify instead of striving to make a killing.
Don't put all your eggs in one basket; if it drops, you're in trouble.
High volatility is like putting your head in the oven and your feet in the refrigerator."
These common sense
sayings capture the essence of Harry Markowitz's brainstorm, sparked one
afternoon as he sat in the University of Chicago library reading a book
about the current thinking of stock market investing. At 25 years old,
Markowitz thought investors should be equally concerned with the volatility
or risk of investments as they are with the return of investments. Thirty-eight
years later, this innovative, practical theory earned him the 1990 Nobel
Prize in Economics. This landmark contribution to the investment world
was first published in 1952 in an essay entitled, "Portfolio
Selection." He later authored a book entitled, Portfolio
Selection: Efficient Diversification of Investments (1959).
Using several stocks from the New York Stock Exchange, Harry Markowitz created the first efficient frontier. The image below and to the left is reproduced from his book, Portfolio Selection, Cowles Monograph 16, Yale University Press, 1959. It has a line going to the origin, because Markowitz was interested in the effects of combining risky assets with a riskless asset: cash.
Read "What to do about the 2008 Financial Transparency Crisis" - Nobel Prize Winner and IFA Academic Consultant Harry Markowitz outlines a solution for resolving the current financial crisis.
Below: An Hour with Harry Markowitz - March 9, 2012
Markowitz was primarily concerned with the diversification of risky assets.
James Tobin added the concept of combining risk-free assets, such as cash
or bonds, with risky assets, such as stocks. His paper, "Liquidity
Preference as Behavior Toward Risk" appeared in The Review of Economic
Studies in February 1958. The concept he described is known as the Separation
Theorem, because it separates Markowitz's approach from the completely
different decision of dividing up the whole portfolio between risky and
Tobin also performed an analysis of financial markets and their relationship to expenditure decisions, debt decisions, employment, production, and prices.
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