STATISTICS

Tests of Random Walk Hypothesis



Tests of Random Walk Hypothesis

Introduction

The study, which is associated with the competent market hypothesis weak, form efficiency, random walk hypothesis and the kinds of random walk hypothesis. Besides it, the random walk hypothesis implies that the price of securities as a random process behavior. It is normally to distributed price variations, a zero expectation value for the distribution of price variations; independent price change as well as non-existent encyclical fluctuations and long term trends anticipated components. The random walk is an immediate consequence of the effective markets theory. In order words, market efficiency hypothesis (EMH) states that the stock returns are uncorrelated and have a constant mean. In the same way, a market is measured as the weak form effective, if the current prices reflects all information contained in the past prices that implies that no investor can plan a trading rule based completely on the historical price patterns to get abnormal returns.

The effective market hypothesis is a concern which is a well documented and studied concept in economics. There is widespread controversy and disagreement on effective market hypothesis as according to some business man and economists, one can beat the market by building arithmetical models and by arithmetical trading. In the view of few business men, by using the technical analysis, an individual can forecast the price of stocks. In this context, the weak form efficiency of market include the price of an asset entails all historical or past financial information about that stocks. The random-walk theory and the theory of symmetric random walk describe the time course of market prices (especially stock prices and other securities prices) mathematically. The theory of random walks is the theory that variations in the value of securities fluctuate randomly around its objective price, opposes the theory of technical analysis. In its most general form, random walks are any random process where the position of a particle at a certain instant depends only on its position at some instant before and some random variable that determines its subsequent direction and step length.

Literature Review

The finding of Lo & MacKinlay which shows positive auto-correlation was not steady with the negative serial correlation (Lo and MacKinlay, 1989, 203-238). According to the past researcher, it is discovered that in the stock market of United States; about forty % of the variation for the returns of longer holding period were anticipated from the information on the past returns (Lo and MacKinlay, 1988, 41-66). In relation to this, the variance of variations that happens weekly should be 5times greater than the variance of the variations that takes place daily with the assumption that the markets keep closed on weekends (Campbell, Lo and MacKinlay, 1997, 18-52). The phenomenon is discovered in the variance ratio test that has been extensively employed to test the random walk-hypothesis in many markets (Fama, 1970, 383-417). The rejection of the random walk hypothesis in prices of share because of mean changing propensity that is a end result of persistence of one ...