The term "random walk" has become so ingrained in the investing culture. What does it actually mean?
For me, it simply means that prices are unpredictable. It also has a technical meaning that, in fact, there are certain statistical properties of prices suggesting that there is no way you can predict the future price based on what has happened in the past. And, therefore, technical analysis is really useless.
Now, the market is not actually a perfect random walk. There is a book, co-authored by my friend [MIT professor] Andy Lo, called A Non-Random Walk Down Wall Street. I don't know how he got that title! He concludes that you can look at statistics and say, "You actually do fail the random-walk hypothesis on many occasions." But the market is very close to a random walk.
In a recent review of the book The Myth of the Rational Market, by financial journalist Justin Fox, you wrote he was not "able to bury the hypothesis that our security markets are usually remarkably efficient." Could you elaborate?
He uses an example in his book, where the efficient-market professor is walking along with one of his students. The student sees a $20 bill and stops to pick it up. The professor says, "Don't stop to pick it up; if it really was a $20 bill, it wouldn't be there." That to me encapsulates the efficient-market theory.
In other words, there is no easy arbitrage opportunity; there is no easy way to pick up the bills. My own feeling about it is not that the $20 bills never exist. But I say pick up the $20 bill fast, because those opportunities aren't going to be there for long. There are just too many smart people out there looking for arbitrage opportunities.
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