What Is Random Walk Of An Economy?

The efficient market view provides an important way of analyzing price movements in organiz3ed markets. Under this approach, the price movements of stocks should look highly erratic, like a random walk, when charted over a period of time.

A price follows a random walk when its movements over time are completely unpredictable. For example, toss a coin for heads or tails. Call a head plus 1 and a tail minus 1. Then keep track of the running score of 100 coin tosses. Draw it on graph paper. This curve is a random walk. Now for comparison also graph 100 days movement of Microsoft stock or of standard and Poor 500 index.

Why do speculative prices resemble a random walk? Economists, on reflection have arrived at the following truths: In an efficient market all predictable things have already been built into the price. It is the arrival of the new information a surprisingly large increase in the consumer price index, a revolution in Saudi Arabia, and a report that the Federal Reserves has unexpectedly raised interest rates that affects stock or commodity prices. Moreover, the news must be random and unpredictable.