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Random Walk Theory of Share Price Movements - Essay Example

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Undergraduate
Essay
Miscellaneous
Pages 3 (753 words)

Summary

A graph of the daily price of a share looks similar to that which would be obtained by plotting a series of cumulative random numbers. This shows clearly that share prices move randomly at the whim of investors, indicating that the market is not price efficient." Contrary to the proposition being made above it has been stated in the finance literature that random walk like movement of the share prices does indicate that the market is price efficient-though differently under to varying degrees of strength of hypotheses…

Extract of sample
Random Walk Theory of Share Price Movements

A lot many efforts were made towards identifying a predictable trading pattern which could be used for chasing profitable deals. From the mid-1950s to the early 1980s, a random walk theory (RWT) of share prices was developed based on the past empirical evidence of randomness in share price movements. RWT basically stated that speculative price changes were independent and identically distributed, so that the past price data had no predictive power for future share price movements. RWT also stated that the distribution of price changes from transaction to transaction had finite variance. In addition, if transactions were fairly uniformly spread across time and were large in numbers, then the Central Limit Theorem suggested that the price changes would be normally distributed. Kendall (1953) calculated the first differences of twenty-two different speculative price series at weekly intervals from 486 to 2,387 terms. He concluded that the random changes from one term to the next were large and obfuscated any systematic effect which may be present. ...
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