Pricing assets: Handshake and the 2013 Nobel Prize for Economics

Pricing assets: Handshake and the 2013 Nobel Prize for Economics
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It’s midday on Monday 14th October 2013 and The Royal Swedish Academy of Sciences has just announced the winners of this year’s Nobel prize for Economics (but see note below). This year it’s been awarded to three economists who have a common focus on the same problem, but who have taken rather different approaches to tackling it, and come up with rather different solutions.

What they all have in common is that they have tried to understand how assets are valued, that is, how do markets decide what something is worth.

Eugene Fama is famous for supporting the “efficient markets” view of pricing, that is, the price of an asset as determined by the market is an efficient processing of all of the available information about that asset. Ironically, what he then went on to show is that, in the short term, it is very difficult to predict the movements of asset prices, such as stocks and shares. This is because at any one time the price of a share has already taken into account all of the available information, and any new information, by definition, is an unknown quantity (a “bit” of information is actually defined as something which halves existing uncertainty). What Fama showed was that when new information becomes available, the price of the asset quickly adjusts to take that new information into account, that is, the market is efficient. The snag is that as no-one can predict what that new information is going to be, it’s very difficult to predict what the new price of the asset is going to be. By implication, Fama was also pointing out that the claims of investment professionals who charge fat fees because they say they are able to predict price movements should be taken with a pinch of salt. One very practical consequence of his work was the invention and growth of “passive investment vehicles”, such as index tracker funds and ETF’s (Exchange Traded Funds) which simply follow rather than try to predict groups of assets.

Robert Shiller appears, on the face of it, to have come to exactly the opposite conclusion as Fama about the pricing of assets by markets. Shiller is famous for arguing that markets are “inefficient”. When pricing assets they tend not to give enough weight to relevant, objective information but instead are overly influenced by irrelevant and irrational, subjective factors. He famously tried to warn investors, and bankers and governments about irrational investor behaviour in the run-up to the dot-com crash of 2000-2001, and again before the sub-prime crisis and financial crisis of 2007/2008 that still engulfs us.

The third economist honoured in this year’s award, Lars Peter Hansen, might be described as the referee or arbiter between Fama and Shiller. He developed the statistical methods that are now used to test the theories of how assets are priced, which allows others to take a view of whether Fama or Shiller offer the better account of what’s going on.

Although this year’s Nobel Economics Prize seems at first sight to have shared the prize amongst three very different, not to say opposed, economists, I think there are important ways in which they are alike, and those are ways that are directly relevant to what Handshake is trying to do.

The first of these is that they are all focused on a problem that is central to Handshake: how can you put a price on an asset? Handshake takes seriously the proposition of the World Economic Forum that personal data is the new asset class. The problem it addresses is how is it possible to put a price on that asset: exactly the kind of problem that Fama, Shiller and Hansen have been addressing, although they have been tackling the price of shares and the value of houses.

Secondly, all three of them agree that the best way to do this is via the creation of a market in which those assets can be traded. They disagree about exactly how good the current markets are at doing that in the case of shares, houses and other “conventional” asset classes, but they agree that what we have is better than non-market alternatives. Handshake is centrally about creating a market where people can find out the true value of personal data and buy and/or sell it on the basis of those prices.

The third way that these three economists agree is that prices are more accurate i.e. are a better reflection of the true value of the asset, when the market is efficient, and therefore the people who create, regulate and operate in markets should be aware of inefficiencies and potential inefficiencies and seek to eliminate or minimise them. Again, that’s exactly what Handshake is doing. It starts from the observation that at the moment there is a kind of rudimentary market in information, but it is very inefficient. There are a lot of reasons why that is the case, but a key one is that the market is massively biased in favour of particular one group of players in the market, namely the big internet companies. Handshake is all about levelling the playing field so that it is fair for all participants.

Finally, there’s a further way in which all three of these Nobel Prize winners agree, and that is that whilst inefficient markets might be exciting (there’s nothing like a big bubble or a massive crash to get the adrenalin flowing) and whilst they may allow some people to make lots of money (usually at the expense of a lot more other people), in the end they are bad news for all of us. They lead us to do stupid things, and to not do things which would be good for us and everybody else. Again, that’s exactly what Handshake believes: because at the moment nobody who might want to sell their personal data has any real idea of what it is worth, and is unable to realise that value, and similarly nobody who wants to acquire data within an efficient market can do so (because it doesn’t yet exist) then the way that personal data is treated doesn’t reflect its true value and potential benefit. Efficient markets make for mutually beneficial behaviours!

Note: The non-Nobel Nobel Prize: Actually, the Economics “Nobel” isn’t actually a Nobel Prize. Economics wasn’t one of the five subjects listed in Alfred Nobel’s will which established the original Nobel Prizes. Instead, the Prize for Economics was established in 1968 by the Sveriges Riksbank – Sweden’s central bank – in memory of Alfred Nobel. However, it is awarded by the same Royal Swedish Academy of Sciences as all the other Nobel Prizes and so in practice has exactly the same status as any other Nobel Prize.