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Stock Market Prices Do Not Follow Random Walks: Evidence From a Simple Specification Test

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  • Andrew W. Lo
  • A. Craig MacKinlay

Abstract

In this paper, we test the random walk hypothesis for weekly stock market returns by comparing variance estimators derived from data sampled at different frequencies. The random walk model is strongly rejected for the entire sample period (1962-1985) and for all sub-periods for a variety of aggregate returns indexes and size-sorted portfolios. Although the rejections are largely due to the behavior of small stocks, they cannot be ascribed to either the effects of infrequent trading or time-varying volatilities. Moreover, the rejection of the random walk cannot be interpreted as supporting a mean-reverting stationary model of asset prices, but is more consistent with a specific nonstationary alternative hypothesis.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2168.

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Date of creation: Feb 1987
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Publication status: published as The Review of Financial Studies, Vol. 1, No. 1, pp. 41-66, (1988).
Handle: RePEc:nbr:nberwo:2168

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  1. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(5), pages 893-920, October.
  2. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, American Finance Association, vol. 25(2), pages 383-417, May.
  3. Summers, Lawrence H, 1986. " Does the Stock Market Rationally Reflect Fundamental Values?," Journal of Finance, American Finance Association, American Finance Association, vol. 41(3), pages 591-601, July.
  4. Robert J. Shiller, 1980. "The Use of Volatility Measures in Assessing Market Efficiency," NBER Working Papers 0565, National Bureau of Economic Research, Inc.
  5. Donald B. Keim & Robert F. Stambaugh, . "Predicting Returns in the Stock and Bond Markets," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 15-85, Wharton School Rodney L. White Center for Financial Research.
  6. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, Econometric Society, vol. 50(4), pages 987-1007, July.
  7. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, Elsevier, vol. 19(1), pages 3-29, September.
  8. Cohen, Kalman J. & Hawawini, Gabriel A. & Maier, Steven F. & Schwartz, Robert A. & Whitcomb, David K., 1983. "Friction in the trading process and the estimation of systematic risk," Journal of Financial Economics, Elsevier, Elsevier, vol. 12(2), pages 263-278, August.
  9. James M. Poterba & Lawrence H. Summers, 1984. "The Persistence of Volatility and Stock Market Fluctuations," NBER Working Papers 1462, National Bureau of Economic Research, Inc.
  10. Campbell, John Y & Mankiw, N Gregory, 1987. "Are Output Fluctuations Transitory?," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 102(4), pages 857-80, November.
  11. Jensen, Michael C., 1978. "Some anomalous evidence regarding market efficiency," Journal of Financial Economics, Elsevier, Elsevier, vol. 6(2-3), pages 95-101.
  12. Phillips, Peter C B, 1988. "Regression Theory for Near-Integrated Time Series," Econometrica, Econometric Society, Econometric Society, vol. 56(5), pages 1021-43, September.
  13. Andrew W. Lo & Craig A. MacKinlay, . "A Simple Specification Test of the Random Walk Hypothesis," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 13-87, Wharton School Rodney L. White Center for Financial Research.
  14. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
  15. Harrison, J Michael & Pitbladdo, Richard & Schaefer, Stephen M, 1984. "Continuous Price Processes in Frictionless Markets Have Infinite Variation," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 57(3), pages 353-65, July.
  16. Merton, Robert C., 1980. "On estimating the expected return on the market : An exploratory investigation," Journal of Financial Economics, Elsevier, Elsevier, vol. 8(4), pages 323-361, December.
  17. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, Econometric Society, vol. 48(4), pages 817-38, May.
  18. Scholes, Myron & Williams, Joseph, 1977. "Estimating betas from nonsynchronous data," Journal of Financial Economics, Elsevier, Elsevier, vol. 5(3), pages 309-327, December.
  19. White, Halbert & Domowitz, Ian, 1984. "Nonlinear Regression with Dependent Observations," Econometrica, Econometric Society, Econometric Society, vol. 52(1), pages 143-61, January.
  20. Pierre Perron & Robert J. Shiller, 1984. "Testing the Random Walk Hypothesis: Power Versus Frequency of Observation," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 732, Cowles Foundation for Research in Economics, Yale University.
  21. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, Econometric Society, vol. 46(6), pages 1429-45, November.
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