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Chapter 2: Question 8-5CP (page 261)

A “random walk” occurs when:

a. Stock price changes are random but predictable.

b. Stock prices respond slowly to both new and old information.

c. Future price changes are uncorrelated with past price changes.

d. Past information is useful in predicting future prices.

Short Answer

Expert verified

The correct answer is ‘c’

Step by step solution

01

Definition

As per the random walk theory, the future of a stock or market cannot be predicted based on its past movement.

02

Explanation

As per the definition above, a random walk implies unpredictable changes in stock prices. It will have no relation with past price change or any other data.

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Most popular questions from this chapter

If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.

An investor takes as large a position as possible when an equilibrium price relationship is violated. This is an example of:

a. A dominance argument.

b. The mean-variance efficient frontier.

c. Arbitrage activity.

d. The capital asset pricing model.

Suppose that as the economy moves through a business cycle, risk premiums also change. For example, in a recession when people are concerned about their jobs, risk tolerance might be lower and risk premiums might be higher. In a booming economy, tolerance for risk might be higher and risk premiums lower.

a. Would a predictably shifting risk premium such as described here be a violation of the efficient market hypothesis?

b. How might a cycle of increasing and decreasing risk premiums create an appearance that stock prices “overreact,” first falling excessively and then seeming to recover?

In Problems 21–23 below, assume the risk-free rate is 8% and the expected rate of return on the market is 18%.

A share of stock is now selling for \(100. It will pay a dividend of \)9 per share at the end of the year. Its beta is 1. What do investors expect the stock to sell for at the end of the year?

Some scholars contend that professional managers are incapable of outperforming the market. Others come to an opposite conclusion. Compare and contrast the assumptions about the stock market that support ( a ) passive portfolio management and ( b ) active portfolio management.
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