DRUNKEN WALKS.

DRUNKEN WALKS. I posted here a couple years ago on a comment by Annalisa that “there appears to be a good deal of randomness as to which stocks do well and which decline.” I have posted several times since on the important theory that stock prices take “random walks.” One variant says that at any moment the prices that are taking the random walk are the best estimates that the participants in the stock market can collectively do, that the prices “fully reflect” available information. In this recent article in the Financial Times, Richard Thaler substitutes the phrase “drunken walk” for “random walk” and poses the important question of how accurate the resulting prices are. Thaler says: “[P]rices can be unpredictable and still wrong; the difference between the random walk fluctuations of correct asset prices and the unpredictable wanderings of a drunk are not discernable.” Annalisa’s comment was made at the beginning of July, 2007, just before a dramatic drop in stock prices. How accurate should we expect stock prices to be if the market is working well? Thaler takes a crack at answering the question, and I will summarize his answer tomorrow (or you can read the article at the link).