Random Walk Hypothesis

The Random Walk Hypothesis is a financial theory that suggests that Stock prices and market indices evolve according to a random walk and thus the future price changes are inDependent of past price changes. This implies that the Stock market is efficient, meaning that all available information is already reflected in Stock prices. Therefore, it is impossible to predict future price movements based on historical data.

One common example of this hypothesis is the performance of Stocks in the Stock market. For instance, if a Stock has been increasing in price, the Random Walk Hypothesis posits that this does not provide any reliable indication that it will continue to increase. Instead, the next price movement is just as likely to be an increase as it is to be a decrease, akin to flipping a coin.

Another case illustrating the Random Walk Hypothesis can be seen in the behavior of a diversified investment portfolio. Over time, the Returns from various Assets in a portfolio may fluctuate inDependently, leading to unpredictable overall portfolio performance. Even with extensive historical analysis, an investor cannot consistently outperform the market by relying on past price trends.