Non-Random Walk Theory

• Economists Andrew W. Lo and A. Craig MacKinlay criticized Malkiel's Random Walk theory in their book, A Non-Random Walk Down Wall Street

Criticisms

• Short Term Momentum, Including Underreaction to New Information

Lo and MacKinley point to the presence of some "momentum" in short-run stock prices. Momentum is a series of repeated price changes in the same direction. Lo and MacKinley also point to the under reaction to new information. This means that the stock is undervalued and that you can profit off of new information.

Malkiel's Response

The statistical dependencies giving rise to momentum are extremely small and unlikely to provide the opportunity to achieve excess gains. Momentum strategies (buying stocks that show positive serial correlation) produced positive relative returns in the 1990s but negative relative returns during 2000. The most predictive patters seem to disappear as quickly as they are published.

• Long Run Return Reversals

Fama and French found that up to 40% of variation in long holding periods can be predicted with a negative correlation with past returns. This supports the contrarian strategy.

Malkiel's Response

Return reversal may be accounted for by efficient function of markets based on the volatility of interest rates. Stock prices must rise and fall to be competitive with bond prices. If interest rates revert to the median over time, this generates return reversals.

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Random Walk | Efficient-Market Hypothesis | Fundamental Analysis | Technical Analysis | Non-Random Walk Theory