Random walk hypothesis

The random walk hypothesis is a financial theory stating that stock market prices evolve according to a random walk (so price changes are random) and thus cannot be predicted. The concept can be traced to French broker Jules Regnault who published a book in 1863, and then to French mathematician Louis Bachelier whose Ph.D. dissertation titled "The Theory of Speculation" (1900) included some remarkable insights and commentary. The same ideas were later developed by MIT Sloan School of Management professor Paul Cootner in his 1964 book The Random Character of Stock Market Prices. The term was popularized by the 1973 book A Random Walk Down Wall Street by Burton Malkiel, a professor of economics at Princeton University, and was used earlier in Eugene Fama's 1965 article "Random Walks In Stock Market Prices", which was a less technical version of his Ph.D. thesis. The theory that stock prices move randomly was earlier proposed by Maurice Kendall in his 1953 paper, The Analysis of Economic Time Series, Part 1: Prices. Whether financial data are a random walk is a venerable and challenging question. One of two possible results are obtained, data are random walk or the data are not. To investigate whether observed data follow a random walk, some methods or approaches have been proposed, for example, the variance ratio (VR) tests, the Hurst exponent and surrogate data testing. Burton G. Malkiel, an economics professor at Princeton University and author of A Random Walk Down Wall Street, performed a test where his students were given a hypothetical stock that was initially worth fifty dollars. The closing stock price for each day was determined by a coin flip. If the result was heads, the price would close a half point higher, but if the result was tails, it would close a half point lower. Thus, each time, the price had a fifty-fifty chance of closing higher or lower than the previous day. Cycles or trends were determined from the tests.