ECO2023 - Stock Market Essay 5

# ECO2023 - Stock Market Essay 5 - I assume that you have...

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I assume that you have read the last essay and know that in an efficient market only new information can change demand and supply and thereby the price. Now, what are the implications of this result? First off, new information will be positive half of the time and negative half of the time. Because stock prices change as a result of new information, the point that new information is positive 50% of the time and negative 50% of the time means that anytime stock’s price changes, there is a 50% chance it will rise and a 50% chance it will fall. With this 50/50 chance of a rise or fall, stock prices are said to follow a “random walk.” To fix the idea of a random walk, think about someone who has too much to drink and is staggering along the road. Each additional step has a 50% chance of staggering to the left and a 50% chance of staggering to the right. This person’s path is a random walk. The idea of a random walk means whether the price of a stock will rise or fall is a 50/50 chance at any time . In other words, if the price rose last time there is still exactly a 50% chance it will rise next time. So, too, if it fell last time: There is still a 50% chance it will rise this time. Stock price changes are essentially like random coin tosses. Randomly toss a coin and 50% of the times it will land heads and 50% of the time it will land tails. As long as the coin is fair, just because the coin landed heads the last time (or even the last 30 times) on the next throw there is still exactly a 50% chance of it coming up heads. Changes in stock prices work the same way: At any given time, there is a 50% chance the price will rise and a 50% chance it will fall. Just because the price rose the last time (or even the last 30 times!) when it changes again there is still exactly a 50% chance of it rising some more. I hasten to add that even though the price changes are random, the

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ECO2023 - Stock Market Essay 5 - I assume that you have...

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