For an electronic copy of this paper, please visit: http://ssrn.com/abstract=350420
Michael C. Jensen will receive the Ph.D. degree shortly from the University of Chicago Graduate Schoolof Business and is currently Assistant Professor of Business Administration at The University of Rochester.The author expresses his appreciation for the helpful comments and criticisms received from Eugene Fama,Myron Gordon, and Myron Scholes.
Random Walks: Reality Or Myth—Comment
Michael C. Jensen
Financial Analysts Journal
, November-December 1967
of statistical investigation of security price movementsby economists and statisticians indicates that successive changes in security prices are(for all practical purposes) independent random variables.
That is, all the statisticalevidence indicates that future security price changes cannot be predicted by using thepast price series. This has become known as the theory of random walks. It impliesthat the trading rules and security selection procedures long advocated by “technical”analysts or “chartists”, which are based solely on past price movements, will not beuseful in aiding the investor to increase his returns.
The technical analysts have re-sponded to the evidence presented by the academicians by claiming their models andtheories are not really captured by these statistical tests. Alexander (1961; 1964) andFama and Blume (1966) have examined the returns earned by various “filter” rulesfor selecting securities which purportedly capture the essence of many technicaltheories. The evidence indicates these trading rules are not able to consistently earn
C.f. Cootner (1964) and Fama (1965).
It is highly unlikely that the random walk theory is an exact description of the behavior of securityprices. From the economist’s point of view it is only important that any dependencies in the price series beso small as to preclude their use in earning higher returns given the transactions costs which exist.