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Randomwalktheory 171025163823

Portfolio Management

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89 views20 pages

Randomwalktheory 171025163823

Portfolio Management

Uploaded by

cmukherjee
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Random walk theory

PRIYANKA
Introduction
1. The theory propounds that the stock prices changes
have the same distribution and are independent of
each other, the past trend of prices or market cannot
be used to predict the future movements
2. In short, stock takes a random and unpredictable path
3. There is a equal chance that the prices will either rise
or fall from current level
4. This theory suggests that the price behavior is never
based on anything predictable but is random
5. This theory believes that price behavior cannot be
predicted because it does not act on any predictive
fundamental or technical indicators
Assumptions
• There is a perfectly competitive market
• Market is supreme
• All investors have the same information
• Stock prices discount all the information quickly
• The prices moves in independent fashion
• Future change in prices will only be as a result of
some other new piece of information which was
not available earlier
Forms of efficiency
• E.F.Fama has provided that the efficiency of
markets depend on the extent of absorption
of information, the time taken for absorption
and the type of information absorbed
Weak form
• The weak form of the market is the oldest
statement
Prices have no memory and yesterday has nothing to so with
tomorrow

• This form of market holds that current prices of


stocks fully reflect all historical information thus
past data cannot be used to predict future prices
• This form asserts that any attempts to predict
prices based on historical information is totally
futile as future price changes are independent of
past price changes
• Past prices are already absorbed by the
market , the prices move in an independent
fashion
Semi strong form(SSF)
 SSF postulates that markets absorb quickly and
efficiently all the publicly available information, as well
as the information regarding historical prices
 Prices adjust to the information quickly and accurately,
abnormal profits cannot be earned on a consistent
basis
 There are some evidences that market does not always
digest the new information correctly but inefficiency of
absorbing data is found to be corrected over a period
of time as investors take time to analyze information
Strong form
• Acc to strong form , the prices of securities fully
reflect all available information both public and
private
• No information that is available be it public or
private can be used to consistently earn superior
investment returns
• It implies that not even security analysts and
portfolio managers who have access to
information more quickly than the general public
are able to use this information to earn superior
returns
Testing techniques of EMH
TESTS OF WEAK FORMS
• Serial correlation test :
1. A certain number of stocks are selected
2. For a particular period the changes in the
prices of these stocks are observed
3. Then in an other period for the same stocks
the changes in the stocks prices are noted
4. If the correlations are closed to zero , the
price changes are said to be serially
independent.
• Runs test :
1. Run test ignored the absolute value of
numbers in the series and took into research
only the positive and negative signs.
2. Count the number of consecutive signs or
runs in same directions
3. In case the sign has changed form a plus to
minus or from minus to a plus a new run is
counted to have begun
• If actual no. of runs is significantly different
from the expected number of runs: the
successive price changes are not considered to
be independent
• If the actual number of runs are not
significantly different from the expected no. of
runs : price changes are considered to be
independent or random
Plus sign indicated : increase in price
Negative sign indicated : decrease in price
Zero indicated : no changes
• Filter tests :
1. Filters are fixed at some percentage change and
price movements are observed
2. If the price movement has exceeded a fixed
level of price movement called support levels,
the stock will move in same direction
Tests of semi strong form
• Markets reaction test :
1. This test tested the speed of the markets
reactions to a firms’ announcement of a stock
split and change in dividend policy
2. During this period the investors could achieve
abnormal returns on the basis of this
information but average cumulative abnormal
returns which was going higher just before the
announcement stopped increasing or decreasing
in any significant manner in the following period
once announcement was made
• earning impact:
1. Examined the effect of annual earnings
announcements
2. They classified firms into 2 groups based on whether
their earnings increased or decreased relative to the
average corporate earnings
3. They found that before the earnings announcement,
stocks associated with increased earnings provided
positive abnormal returns and the stocks associated
with decreased earnings provided negative abnormal
returns.
• Secondary offerings impact:
1. This test observe the reaction of security prices to the
offer of secondary stock issues
2. The study showed that the price of security decreases
when the issuer was a company which indicated to
the market that such an offer contained some bad
news but secondary offerings by banks and insurance
companies were not viewed in a negative manner and
the security prices did not fall significantly.
3. The study proved that the price behavior of secondary
issues lent support with the market just to a new
piece of information in an unbiased manner and
almost immediately
• Block trade impact :
1. Study to examine the effects of large block
trades on the behavior of security prices
2. There was a temporary effect on share price
which was associated with the block trade
3. There was no price behaviour which could be
predicted after the day on which the block
trade occured
• Bonus impact :
1. Even though the bonus issue never brings
any additional value to investors, yet it does
the expectations regarding future
2. As a result the adjustment which starts well
before such announcement is less than
accurate as against one to one adjustment
with the bonus ratio
Tests of strong form
• Trading by stock exchange officials :
1. Top officials of the stock exchanges have
access to all the information on the
overbought or oversold position.
2. If pvt. Information is of no use it should not
be possible for them to make profits using
the information
3. Studies carried out in U.S.A in the profits
made by such experts who have access to
such information have showed that experts
consistently make abnormal profits
• Trading by mutual fund managers :
1. Mutual fund managers are supposed to be
experts in investment decision making and
are able to get that information which is not
accessible to the common man
2. The studies showed that the mutual funds
were into better in performance than an
individual investor who purchased the same
securities with the same risk

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