What is MPT theory?
The Modern portfolio theory {MPT}, "proposes how rational investors will use diversification to optimize their portfolios, and how an asset should be priced given its risk relative to the market as a whole. The basic concepts of the theory are the efficient frontier, Capital Asset Pricing Model and beta coefficient, the Capital Market Line and the Securities Market Line. MPT models the return of an asset as a random variable and a portfolio as a weighted combination of assets; the return of a portfolio is thus also a random variable and consequently has an expected value and a variance.
What is the efficient market hypothesis?
The efficient market hypothesis implies that it is not generally possible to make above-average returns in the stock market by trading (including market timing), except through luck or obtaining and trading on inside information. (Wikipedia b, 2005) The EMH comes in three forms.
What Is The Random Walk Theory?
Random walk theory suggests that changes in stock prices have the same distribution and are independent of each other. Therefore, it assumes the past movement or trendof a stock price or market cannot be used to predict its future movement. In short, random walk theory proclaims that stocks take a random an…
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Understanding Random Walk Theory
Random walk theory believes it's impossible to outperform the market without assuming additional risk. It considers technical analysis undependable because chartists only buy or sell a security after an established trend has developed. Likewise, the theory finds fundamental analysis undependable due to the often-poor quality of information collected and its ability to be misinter…
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Efficient Markets Are Random
The random walk theory raised many eyebrows in 1973 when author Burton Malkiel coined the term in his book "A Random Walk Down Wall Street."1 The book popularized the efficient market hypothesis (EMH), an earlier theory posed by University of Chicago professor William Sharp. The efficient market hypothesis states that stock prices fully reflect all available information and exp…
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Random Walk Theory in Action
The most well-known practical example of random walk theory occurred in 1988 when theWall Street Journalsought to test Malkiel's theory by creating the annual Wall Street Journal Dartboard Contest, pitting professional investors against darts for stock-picking supremacy. Wall Street Journal staff members played the role of the dart-throwing monkeys.3 After more than 140 co…
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What Is The Random Walk Theory?
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How Does The Random Walk Theory Work?
The central idea behind the random walk theory is that the randomness of stock prices renders attempts to find price patterns or take advantage of new information futile. In particular, the theory claims that day-to-day stock prices are independent of each other, meaning that momentum does not generally exist and calculations of past earnings growth does not predict f…
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Why Does The Random Walk Theory Matter?
The random walk theory proclaims that it is impossible to consistently outperform the market, particularly in the short-term, because it is impossible to predict stock prices. This may be controversial, but by far the most controversial aspect of the theory is its claim that analysts and professional advisors add little or no value to portfolios. As Malkiel put it, 'Investment advisory s…
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