Efficient Market Hypothesis |authorSTREAM
Market participants distinguish among three forms of the efficient market hypothesis. The weak form asserts that all information to be derived from past trading data already is reflected in stock prices. The semistrong form claims that all publicly available information is already reflected. The strong form, which generally is acknowledged to be extreme, asserts that all information, including insider information, is reflected in prices.
Definition of random walk in the ..
Statistical research has shown that to a close approximation stock prices seem to follow a random walk with no discernible predictable patterns that investors can exploit. Such findings are now taken to be evidence of market efficiency, that is, evidence that market prices reflect all currently available information. Only new information will move stock prices, and this information is equally likely to be good news or bad news.
Bachelier’s original version of the random walk hypothesis was crude by today’s standards. It had prices follow an arithmetic random walk with zero drift. The modern version developed out of the work of multiple researchers, including those already mentioned, as well as Osborne (1959), Moore (1960), Alexander (1961. 1964) and Granger and Morgenstern (1963). It states that the log returns follow an arithmetic random walk with a drift reflecting the long-term return from equity investment. Stated another way, prices follow a geometric random walk with drift.
The random walk hypothesis is more an empirical observation than a theoretical result. Fundamentally, it is an empirical observation that price series are well modeled with a random walk. However, researchers did offer a theoretical explanation for why prices should follow a random walk. They noted that prices change in response to news items—earnings reports, releases of economic indicators, merger announcements, etc. If news items are assumed to arise independently (the relative probabilities of upcoming news being good or bad is unaffected by whether recent news has been good or bad) then price changes should be independent. Also, the volume of news items affecting a price is sufficiently large that the central limit theorem applies, and price changes over any discernible period should be approximately normal. Somewhat after the fact, Samuelson (1965) and Mandelbrot (1966) rigorously formalized this theoretical justification of the random walk hypothesis.