Random Walks in Stock- Market Prices

Selected Papers l No. 16 Random Walks in Stock- Market Prices By EUGENE F. FAMA GRADUATE SCHOOL OF BUSINESS UNIVERSITY OF CHICAGO EUGENE F. FAMA is the Theodore 0. Yntema Pro- fessor of Finance at the Graduate School of Busi- ness of the University of Chicago. His research interests encompass the broad areas of economics, finance, statistics, mathematical methods, and com- puters, and he has been particularly concerned zoith the behavior of stock-market prices. A leader in developing the so-called “efficient markets” hy- pothesis, his influential writings have stimulated a large volume of related research at Chicago and elsewhere. Professor Fama received the B.A. degree (magna cum laude) from Tufts University in 1960 and the Ph.D. degree from the University

of Chi- cago in 1964. His doctoral dissertation, “The Be- havior of Stock-Market Prices,” was published in the Journal of Business, January, 1965. It discussed the theory of random walks in substantial detail and provided extensive empirical evidence to sup- port the theory. This Selected Paper-a condensed, nontechnical version of that article-initially was delivered as a talk at the 1965 Management Con- ference of the Graduate School of Business and the Executive Program Club. Random Walks in Stock- Market Prices FOR MANY YEARS economists, statisticians, and teachers of finance have been inter- ested in developing and testing models of stock price behavior. One important model that has evolved from this research is the theory of random walks. This theory casts serious doubt on many other methods for describing and predicting stock price be- havior-methods that have considerable popularity outside the academic world. For example, we shall see later that, if the ran- dom-walk theory is an accurate description of reality, then the various “technical” or “chartist” procedures for predicting stock prices are completely without value. In general, the theory of random walks raises challenging questions for anyone who has more than a passing interest in under- standing the behavior of stock prices. Un- fortunately, however, most discussions of the theory have appeared in technical aca- demic journals and in a form which the non-mathematician would usually find in- comprehensible. This paper describes, brief- ly and simply, the theory of random walks and some of the important issues it raises concerning the work of market analysts. To preserve brevity, some aspects of the theory and its implications are omitted. More com- plete (but also more technical) discussions of the theory of random walks are available elsewhere; hopefully, the introduction pro- vided here will encourage the reader to ex- amine one of the more rigorous and lengthy works listed at the end of the paper. 2 Common Predictive Techniques In order to put the theory of random walks into perspective, we first discuss, in brief and general terms, the two approaches to predicting stock prices that are common- ly espoused by market professionals. These are (1) “chartist” or “technical” theories and (2) the theory of fundamental or in- trinsic value analysis. The basic assumption of all the chartist or technical theories is that history tends to repeat itself, that is, past patterns of price behavior in individual securities will tend to recur...

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