Oct. 8 (Bloomberg) -- U.S. economics professors Robert F. Engle and Clive W. J. Granger won this year's Nobel prize in economics for developing ways to improve economic forecasting and better predict volatility in financial markets, such as the events that led to the stock market crash of 1987.

The discoveries of Engle, 60, a professor of economics at the Stern School of Business at New York University, and Granger, 69, who retired June 30 as economics professor at the University of California in San Diego, revolutionized the way investors and analysts use economic statistics to assess market risk, economists said.

``They are responsible for the only serious attack on one very important question for economics,'' said Massachusetts Institute of Technology professor emeritus Robert Solow, the 1987 winner of the Nobel for economics. ``If you want to understand the connections between important economic quantities that change over time, you need a serious, careful method for connecting your picture with the data you actually observe, and that's what Granger and Engle did.''

Engle and Granger constructed computer models showing how trends reflected in economic and financial statistics -- ranging from corporate profits to productivity -- could be used to predict the price volatility of stocks, derivatives and other financial instruments.

The Nobel prize in economics is awarded by the Royal Swedish Academy of Sciences. Former winners include Milton Friedman of the University of Chicago and Robert Mundell of Columbia University. Engle and Granger will share a prize of $1.3 million.

`Enormous Ramifications'

Awards for achievements in physics, chemistry, medicine, peace and literature were established by Alfred Nobel, the Swede who invented dynamite, in his will in 1896. The economics prize was instituted by Sweden's central bank in 1968 in his memory.

``It's a terrific choice,'' said Dale Jorgenson, a Harvard University economics professor who is familiar with the men's work. ``These two have solved a problem that economists have been struggling with for years -- how to apply the trends that show up in various economic statistics to see how they relate to one another and to predict how that will drive our economy and the financial markets. It's had enormous ramifications.''

Engle, on sabbatical in rural Annecy, France, said in a telephone interview with Bloomberg News that he and Granger became interested in the issue during the 1980s, when volatility in global financial markets began having a large impact on the U.S. and other major economies.

1987 Market Crash

After the U.S. stock market crash of 1987, he recalled, ``there was a big question of how volatile markets were going to be in the future. What we found was that volatility has a life of its own, and you can track it and use statistical methods to try to forecast how long each movement will last.''

The two worked together when both were at the University of California at San Diego. Granger concentrated on how to use these statistics to forecast economic trends, while Engle showed how they can help predict volatility. Granger, now a visiting professor at the University of Canterbury in Christchurch, New Zealand, couldn't immediately be reached.

``These days, we're pretty well certain that the performance of corporate earnings are the major determinant in how stock prices will go, but that wasn't true in 1987,'' Jorgenson said. ``Engle and Granger show how we could link these and other statistics. It's had very important practical implications.''

Jorgenson said the work of Granger and Engle was a major influence on the contention of Yale University's Robert Shiller that the U.S. stock market was overvalued just before stock prices collapsed in 2000. Shiller couldn't immediately be reached.

Buy-and-Hold Investor

Engle told reporters in a telephone conference call from France later that ``high-volatility periods probably will die out and we'll have more stable financial markets'' in coming years. He also said his current work has confirmed that there's a strong correlation between what happens in financial markets around the world. He said forecasters must consider both short-term developments and long-term factors in predicting volatility and risk.

Asked whether his Nobel prize-winning work has proven useful to him in managing his own personal investment portfolio, Engle said he hadn't.

``I'm a pretty straightforward buy-and-hold investor,'' he said. ``I don't actually use that in my own portfolio.''

The choice of two macroeconomists was a departure from the Swedish Academy's recent history, which has been choosing winners from other disciplines. Last year, the prize went jointly to Vernon L. Smith, a microeconomics specialist at George Mason University in Fairfax, Virginia, and Daniel Kahneman, a psychology professor at Princeton University, for helping to shed light on how people make decisions about financial transactions and investments.

Analyzing `Time Series'

The Nobel committee said Engle was selected for having developed ``methods of analyzing economic time series with time- varying volatility,'' while Granger was chosen for devising ways to analyze ``economic time series with common trends.''

Granger, was born in Swansea, Wales, and received a doctorate in statistics from the University of Nottingham in 1959. He has been on the faculty of the University of California at San Diego since 1974.

Engle received his doctorate in economics from Cornell University in 1969. He is a principal in Robert F. Engle Econometric Services, a consulting firm in New York.

Last Updated: October 8, 2003 17:53 EDT