Professional Documents
Culture Documents
16
l
Random Walks
in StockMarket Prices
By EUGENE F. FAMA
EUGENE F. FAMA
the
of
interests
University
of
Chicago.
His
research
finance, statistics, mathematical methods, and computers, and he has been particularly concerned
zoith the behavior of stock-market prices. A leader
in developing the so-called efficient markets hypothesis, his influential writings have stimulated
a large
elsewhere.
Professor
Fama
received
the
B.A.
degree
in 1964. His doctoral dissertation, The Beof Stock-Market Prices, was published in
the
the
and
provided
port
the
extensive
theory.
nontechnical
This
version
empirical
Selected
of
that
evidence
Paper-a
to
sup-
condensed,
article-initially
was
Program
Club.
Random Walks in
Stock- Market Prices
FOR
The assumption of the fundamental analysis approach is that at any point in time an
individual security has an intrinsic value
(or, in the terms of the economist, an equilibrium price) which depends on the earning potential of the security. The earning
potential of the security depends in turn on
such fundamental factors as quality of management, outlook for the industry and the
economy, etc.
Through a careful study of these fundamental factors the analyst should, in principle, be able to determine whether the actual price of a security is above or below
its intrinsic value. If actual prices tend to
move toward intrinsic values, then attempting to determine the intrinsic value of a
security is equivalent to making a prediction of its future price; and this is the essence of the predictive procedure implicit
in fundamental analysis.
Theory of Random Walks
Chartist theories and the theory of fundamental analysis are really the province of
the market professional and, to a large extent, of teachers of finance. Historically,
however, there has been a large body of
academic people, primarily economists and
statisticians, who subscribe to a radically different approach to market analysis-the theory of random walks in stock-market prices.
The remainder of this paper will be devoted to a discussion of this theory and its
major implications.
Random-walk theorists usually start from
the premise that the major security exchanges are good examples of efficient
markets. An efficient market is defined as
a market where there are large numbers of
rational profit-maximizers actively competing, with each trying to predict future market values of individual securities, and
where important current information is almost freely available to all participants.
In an efficient market, competition among
the many intelligent participants leads to a
situation where, at any point in time, actual prices of individual securities already
reflect the effects of information based both
on events that have already occurred and
on events which as of now the market expects to take place in the future. In other
words, in an efficient market at any point
in time the actual price of a security will be
a good estimate of its intrinsic value.
Now in an uncertain world the intrinsic
value of a security can never be determined
exactly. Thus there is always room for disagreement among market participants concerning just what the intrinsic value of an
individual security is, and such disagreement will give rise to discrepancies between
actual prices and intrinsic values. In an efficient market, however, the actions of the
many competing participants should cause
the actual price of a security to wander randomly about its intrinsic value. If the discrepancies between actual prices and intrinsic values are systematic rather than random in nature, then knowledge of this
should help intelligent market participants
to better predict the path by which actual
prices will move toward intrinsic values.
When the many intelligent traders attempt
to take advantage of this knowledge, however, they will tend to neutralize such systematic behavior in price series. Although
uncertainty concerning intrinsic values will
remain, actual prices of securities will wander randomly about their intrinsic values.
New
Information
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REFERENCES
1 . ALEXANDER, SIDNEY S. Price Movements in
Speculative Markets: Trends or Random
II
Walks,
(May, 1961), 7-26.
2. ---. Price Movements in Speculative Markets: Trends or Random Walks, Number 2,
ibid., V (Spring, 1964), 25-46.
3. COOTNER, PAUL H. (ed). The Random Character
of Stock Market Prices. Cambridge: M.I.T.
Press, 1964. An excellent compilation of research on the theory of random walks completed prior to mid-1963.
4. C OOTNER, PAUL H. Stock Prices: Random vs.
Systematic Changes, Industrial Management
III, (Spring, 1962), 24-45.
5. FAMA, EUGENE F. The Behavior of Stock-Market Prices, Journal of Business, XXXVIII
(January, 1965), 34-105.
6. FISHER, L., and LORIE , J. H. Rates of Return
on Investments in Common Stocks, Journal
of Business, XXXVJI (January, 1964), 1-21.
7. GODFREY, MICHAEL D., GRANCER, CLIVE W. J.,
and MORGENSTERN, OSKAR. The Random Walk
Hypothesis of Stock Market Behavior, Kyklos,
XVII (January, 1964), l-30.
8 . GRANGER, CLIVE W. J., and MORGENSTERN, 0.
Spectral Analysis of New York Stock Market
Prices, Kyklos, XVI (January, 1963), I-27.
9. KENDALL, M. G. The Analysis of Economic
Time Series, Journal of the Royal Statisticol
Society (Series A), XCVI (1953), 11-25.
10. M O O R E, AR N O L D . A Statistical Analysis of Common-Stock Prices. Unpublished Ph.D. dissertation, Graduate School of Business, University
of Chicago (1962).
11. A Study of Mutual Funds. Prepared for the
Securities and Exchange Commission by the
Wharton School of Finance and Commerce.
Report o f the Committee on Interstate and Foreign Commerce. Washington, DC.: Government Printing Office, 1962.