Robert Shiller

Excess volatility – Irrational changes in stock prices

Shiller’s work revolutionized how economists analyze and predict market behavior, demonstrating how the market does not always follow a rational and efficient model, rather it reflects the irrational nature of investors.

In his 1981 paper, Shiller found an anomaly in the efficient market hypothesis model (EMH). He observed that changes in stock prices are due to rational responses to new information. Through econometric analyses of market data, Shiller demonstrated that there was an excessive amount of volatility in stock prices that could not solely be explained by new information/changes in actual dividends. ³

“How errors of human judgment can infect even the smartest people, thanks to overconfidence, lack of attention to details, and excessive trust in the judgments of others, stemming from a failure to understand that others are not making independent judgments but are themselves following still others—the blind leading the blind.”

― Robert J. Shiller, Irrational Exuberance

Let’s break this down further. Stock prices serve as forecasts for dividends. Dividends refer to the actual returns that a stockholder receives. Shiller’s conclusion states that the stock prices were far more erratic than the returns of the market, thus the market was behaving inefficiently. For example, from 1994-2000 the stock market boomed. However, indicators of economic growth, gross domestic product, and corporate profits failed to demonstrate the same level of actual growth.⁴

These results prompted Shiller to call for a deepened understanding of investor psychology, beliefs, and expectations. Shiller’s pushback against the rational model was controversial but was corroborated by a growing number of behavioral economists.

Shiller provides a simple explanation of his work with Eugene Fama and Lars Hansen in a 2013 Nobel Prize interview, where he was asked to explain his work to a 13-year-old audience:

“We have done work on understanding what drives these markets and why do they move through time, and what patterns can you expect them to show? Looking at it from my perspective I was always among the three of us the one that was most sceptical about rationality of human behaviour. Basically, these markets can go crazy sometimes and that was my view and it coloured the kind of work that I did. I don’t know that I proved that markets go crazy, but I think that the evidence that I showed inclines really in that direction.” [5]

Narrative Economics – The economic power of a story

This concept expanded the traditional study of economics by acknowledging the underlying economic power of narratives by calling for a deeper understanding of how stories can spread and influence financial occurrences.

As a pioneer of the field, Shiller considers narrative economics a subset of behavioral economics, yet he notes the distinctions between the two fields: behavioral economics looks for behavioral inconsistencies that influence economics, whereas narrative economics looks at how different stories influence economic behaviors.⁶ We think in stories, communicate ideas through stories, and make decisions based on stories. Thus, the spread of narratives is of major relevance to global financial events and must be recognized within economics.

“We need to incorporate the contagion of narratives into economic theory. Otherwise, we remain blind to a very real, very palpable, very important mechanism for economic change, as well as a crucial element for economic forecasting. If we do not understand the epidemics of popular narratives, we do not fully understand changes in the economy and in economic behavior.”

― Robert J Shiller, Narrative Economics: How Stories Go Viral and Drive Major Economic Events

Shiller talks about “perennial narratives”, or narratives that have repeated throughout history in different forms. One example is the “labor-saving machine” narrative. This refers to the fear that novel machines will be taking our jobs, whether it is mechanical looms in the 1800s or artificial technology in the present day. The spreading public discussion of these fears can impact individual investment, consumption, and voting behavior, all of which are driving forces in economic fluctuation. ²

Shiller’s book Narrative Economics was published in 2019, so the ramifications of this area of study will be of interest in the coming years. However, through looking at popular narratives and their spread, Shiller has been able to grant insight on pertinent economic events such as the rise of Bitcoin, housing crashes, and financial panic.

“The key to achieving our goals and enhancing human values is to maintain and continually improve a democratic financial system that takes account of the diversity of human motives and drives. 

― Robert J. Shiller, Finance and the Good Society

Robert J Shiller was born March 29, 1946, in Detroit, Michigan. As a young child, Shiller’s exceedingly energetic and talkative nature didn’t always yield academic success. Yet, Shiller was a strong reader with a particular interest in the physical sciences. After reading his older brother’s copy of Paul Samuelson’s Economics in high school, Shiller began to see economics as a science and an important tool to explain the world around us. ⁷ To this day, Shiller’s scientific attention to detail and focus on real-world observation lies at the foundation of his economic research.

“But the way I view it is that human nature has evolved for millions of years of evolution and every little desire, demand or impulse that we have served some purpose some time in history. And who knows — it may seem like a crazy quilt of emotions that we have, and we’ll never completely understand where they came from. But they drive us.”

― Robert Shiller, “An Interview with Robert Shiller” by Connor Clarke for The Atlantic

While receiving his doctorate at MIT, Shiller found himself learning from the minds that drove him towards economics in the first place, with Paul Samuelson as his teacher and future Nobel laureate Franco Modigliani as his advisor. Despite their sometimes diverging perspectives, Franco’s moral imperative and focus on rigorous econometric models remained major influences on Shiller’s contributions. Post-graduate school, Shiller met his wife Ginny, a clinical psychologist and academic, who he cites as a major influence on his work and writing.⁸

“Excess volatility is just one example of how the inconsistency of human behavior is a potent force. The human mind is incredibly powerful; it is capable of computations that can dazzle you, but can also be very blundering and foolish at times”

― Robert Shiller, “An Interview with Robert Shiller” by John Y. Campbell for Macroeconomic Dynamics 

Shiller’s pivotal paper in 1981 demonstrated, through an array of econometric data, that excess volatility in stock prices results in anomalies within the widely-accepted rational model.¹ From here Shiller began to branch more into the realm of “behavioral finance” as he worked with renowned behavioral economist Richard Thaler to set up the National Bureau of Economics Research (NBER) conferences exploring the burgeoning field.⁸ Additionally, Shiller increasingly focused on the conditions of economic “bubbles”, first looking at the “dot-com” bubble in the ’90s and the housing market bubble in the 2000s, both of which are the subjects of his best-selling book Irrational Exuberance.

In the past 20 years, Shiller has highlighted through various popular and academic works how much the American economy is driven by the beliefs of its participants. He has also consistently pushed for a re-thinking of finance in order to prioritize and facilitate public good.

“It is hard to be an innovator because it is not a traditional course in the profession. It tends to look nutty. Well, the Wright brothers were thought of as nutty by many when they tried to develop the airplane. Today, new designers of airplanes are fully respected. But, today, in mechanism design or other constructive aspects of economics, we are in the Wright Flyer stage.”

-Robert Shiller, “An Interview with Robert Shiller” by John Y. Campbell for Macroeconomic Dynamics 

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof and Robert J. Shiller

In the wake of the 2008 financial crisis, this book explores how the underlying drives of our emotions and beliefs, referred to as animal spirits, influence economic decision making. Akerlof and Shiller elaborate on different animal spirits, such as confidence, fairness, and corruption, and how they play a role in answering major economic questions.

Robert Shiller – How Human Psychology Drives the Economy – from the Royal Society for the Arts

In this video, Shiller presents major concepts of his book Animal Spirits, and the ways in which the study of economics has overlooked data and market phenomena that lies outside of a rational model.

Narrative Economics: Robert Shiller – YouTube video by Yale School of Management

In this short video, Shiller explains the epidemiological foundations of narrative economics and gives pertinent case studies in how economic narratives can take wind.

Robert Shiller: A Skeptic and a Nobel Winner – from The New York Times

Financial columnist Jeff Sommer questions Shiller on his Nobel Prize-winning work, efficient market theory, real estate bubbles and more, in this 2013 interview.

Financial Collapse: A Panel with Nassim N. Taleb & Robert Shiller (2014)

Nick Paumgarten of the New Yorker holds a panel with challengers of economic conventionalism, Nassim Taleb and Robert Shiller to discuss the role of economics and frameworks of financial collapse.

1. Case, K. E., & Shiller, R. J. (2003). Is There a Bubble in the Housing Market? Brookings Papers on Economic Activity, 2003(2), 299–362. https://doi.org/10.1353/eca.2004.0004
2. Shiller, R. J. (2019). Narrative Economics: How Stories Go Viral and Drive Major Economic Events (Illustrated Edition). Princeton University Press.
3. Shiller, R. J. (1981). Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends? The American Economic Review, 71(3), 421–436. JSTOR.
4. Shiller, R. J. (2006). Irrational Exuberance (2nd Edition). Crown Business.
5. Transcript from an interview with Robert J. Shiller. (2013, December 6). NobelPrize.org. Nobel Media AB 2020. https://www.nobelprize.org/prizes/economic-sciences/2013/shiller/160437-robert-j-shiller-interview-transcript/
6. YaleCourses. (2019, September 12). Robert Shiller on Narrative Economics. https://www.youtube.com/watch?v=yLsG4R8FFOc
7. Robert J. Shiller. (2013). Robert J Shiller—Biographical. NobelPrize.org. Retrieved October 21, 2020, from https://www.nobelprize.org/prizes/economic-sciences/2013/shiller/biographical/
8. Campbell, J. Y. (2004). AN INTERVIEW WITH ROBERT J. SHILLER. Macroeconomic Dynamics, 8(5), 649–683. https://doi.org/10.1017/S1365100504040027