[T1W5] - MARKET EFFICIENCY
RANDOM WALK HYPOTHESIS
A random walk hypothesis assets that security price changes are (random) unpredictable.
● Changes in price are driven by relevant new information which, by definition, is not known
beforehand and arrives in a random fashion
● No discernible trends in prices and cannot predict changes in price
A variable’s serial correlation is measured at zero. (At zero, there is no correlation and observations are
independent.) If a serial correlation between successive price changes is significantly different from zero,
then prices do not follow a random walk.
Securities assumed to follow a random walk when prices drift upwards over the long-term. This
upwards drift represents the rate of return that investors require in return for taking on the risk
inherent in the security.
EFFICIENT MARKET HYPOTHESIS (EMH)
Information sets:
Weak-Form Hypothesis
Market prices reflect all information that can be inferred from past price changes.
Bruno Solnik in 1973 - Test of weak-form EMH
It is difficult to prove EMH but it is possible to try disproving it and fail to find sufficient evident to
disprove it.
Tested serial correlation between successive returns over different time-frames and for major stock
market indices from different countries.
Results:
RANDOM WALK HYPOTHESIS
A random walk hypothesis assets that security price changes are (random) unpredictable.
● Changes in price are driven by relevant new information which, by definition, is not known
beforehand and arrives in a random fashion
● No discernible trends in prices and cannot predict changes in price
A variable’s serial correlation is measured at zero. (At zero, there is no correlation and observations are
independent.) If a serial correlation between successive price changes is significantly different from zero,
then prices do not follow a random walk.
Securities assumed to follow a random walk when prices drift upwards over the long-term. This
upwards drift represents the rate of return that investors require in return for taking on the risk
inherent in the security.
EFFICIENT MARKET HYPOTHESIS (EMH)
Information sets:
Weak-Form Hypothesis
Market prices reflect all information that can be inferred from past price changes.
Bruno Solnik in 1973 - Test of weak-form EMH
It is difficult to prove EMH but it is possible to try disproving it and fail to find sufficient evident to
disprove it.
Tested serial correlation between successive returns over different time-frames and for major stock
market indices from different countries.
Results:
