When the stock price follows a random walk, the price today is said to be equal to the prior period price plus the expected return for the period with any remaining difference to the actual return due to:
A)a predictable amount based on the past prices.
B)a component based on new information unrelated to past prices.
C)the security's risk.
D)the risk free rate.
E)None of the above.

Question

Quizplus · Accepted Answer

When the stock price follows a random walk, the price today is said to be equal to the prior period price plus the expected return for the period with any remaining difference to the actual return due to new information unrelated to past prices. The randomness of stock prices means that past prices cannot be used to predict future prices, and any predictable component would violate the assumption of a random walk. The remaining difference between the expected return and the actual return can be attributed to new, unexpected information that affects the market's perception of the security's value. Risk and the risk-free rate may affect expected returns, but they are not what causes the deviation from expected returns in a random walk.

When the Stock Price Follows a Random Walk, the Price