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Random walks and the temporal dimension of risk

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  • Estrada, Javier

Abstract

The assumption that stock prices follow a random walk has critical implications for investors and firms. Among those implications is the fact that data frequencies and investment horizons are irrelevant (as defined below) when evaluating the risk of a security. However, if stock prices do not follow a random walk, ignoring either issue may lead investors to make misleading decisions. Using data from the first half of _the decade for thirteen European securities markets, I first argue that stock prices in these markets (not surprisingly) do not follow a random walk. Then, I show that investors that assume otherwise are bound to underestimate the total and systematic risk (and overestimate the compound and risk-adjusted returns) of European stocks. The underestimation of risk ranges between .53% and 2.94% a month, and averages 1.25% a month.

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  • Estrada, Javier, 1997. "Random walks and the temporal dimension of risk," DEE - Working Papers. Business Economics. WB 7040, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    • Handle: RePEc:cte:wbrepe:7040
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    References listed on IDEAS

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    Cited by:

    1. Aparicio, Felipe M. & Estrada, Javier, 1997. "Empirical distributions of stock returns: european securities markets, 1990-95," DEE - Working Papers. Business Economics. WB 7054, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    2. Dima, Bogdan & Barna, Flavia & Pirtea, Marilen & Nachescu, Miruna, 2007. "The Analisis Of The Bet-Fi Index’S Static Properties," MPRA Paper 5871, University Library of Munich, Germany.
    3. Barna, Flavia & Dima, Bogdan & Labunet, Aurora, 2003. "Eficienţa Pieţei Financiare Din România - Condiţie Necesară În Perspectiva Aderării La Uniunea Europeană," MPRA Paper 5870, University Library of Munich, Germany.

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