The Behavior of Stock-Market Prices

Abstract

This paper discusses the theory of random-walk model and then tests the model's empirical validity. The main conclusion will be that the data seem to present consistent and strong support for the model. This implies, of course, that chart reading, though perhaps an interesting pastime, is of no real value to the stock market investor. This is an extreme statement and the chart reader is certainly free to take exception. Since the empirical evidence produced by this and other studies in support of the random-walk model is now so voluminous, the counterarguments of the chart reader will be completely lacking in force if they are not equally well supported by empirical work. By contrast the stock market trader has a much more practical criterion for judging what constitutes important dependence in successive price changes. For his purposes the random walk model is valid as long, as knowledge of the past behavior of the series of price changes cannot be used to increase expected gains. More specifically, the independence assumption is an adequate description of reality as long as the actual degree of dependence in the series of price changes is not sufficient to allow the past history of the series to be used to predict the future in a way, which makes expected profits greater than they would be under a naive buy-and-hold model.