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Random Walk Essay

  • Submitted by: mystique84
  • on December 6, 2011
  • Category: English
  • Length: 1,278 words

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Below is an essay on "Random Walk" from Anti Essays, your source for research papers, essays, and term paper examples.

Introduction The Market Efficiency Hypothesis is one of the most researched areas of finance. In its weak form, the hypothesis states that the asset prices cannot be determined based on the past movements in the prices. In this report, we test this conclusion on the popular market indices: Dow Jones Industrial Average (DJIA), S&P 500 and Nasdaq Composite (NSDQ). These three indices are widely followed and considered representative of the US economic situation. In this section we will look at the major characteristics of each of the indices and their movement through the past two decades.
Dow Jones Industrial Average (DJIA) consists of 30 component companies from various industries in the US, including manufacturing, retail, finance and IT. It is a price weighted index and the value of the index is the sum of its component prices divided by a divisor which factors in stock splits and dividend announcements. Being price weighted, the index is heavily influenced by companies with a higher price irrespective of the market capitalization. The daily index levels for each of the three indices are obtained for the last 20 years and the continuous daily returns are calculated. The time series plots of the index, its returns and the descriptive statistics of the returns are presented in Exhibit 1. As expected price level of the DJIA is not stationary. For instance, there was a steep increase ‘91 to ‘99, followed by a sudden decrease from until ’03, (owing to the dotcom boom and bust), reflecting unstable volatility and mean. We also conducted ADF test to test unit root, the result had a p-value of 0.4261, showing the inability to reject the null hypothesis that the series is non-stationary at 5% significance level. The daily returns have a mean value close to zero as seen from the time series plot and the descriptive statistics. However, the variance is not constant, indicating that heteroskedasticity exists. The huge increase in the volatility may be attributed to the...

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