Publication: Random walks and the temporal dimension of risk
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1997-04
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Abstract
The assumption that stock prices follow a random walk has critical implications for investors
and firms. Among those implications is the fact that data frequencies and investment horizons
are irrelevant (as defined below) when evaluating the risk of a security. However, if stock
prices do not follow a random walk, ignoring either issue may lead investors to make
misleading decisions. Using data from the first half of _the decade for thirteen European
securities markets, I first argue that stock prices in these markets (not surprisingly) do not
follow a random walk. Then, I show that investors that assume otherwise are bound to
underestimate the total and systematic risk (and overestimate the compound and risk-adjusted
returns) of European stocks. The underestimation of risk ranges between .53% and 2.94% a
month, and averages 1.25% a month.
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Time series of stock returns, Random walks, Risk