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 these.

Question

Quizplus · Accepted Answer

A random walk means that the past prices hold no information about future prices, so there is no predictable amount based on the past prices (A). The expected return for the period is incorporated into the prior period price, so it cannot be due to (C) the security's risk or (D) the risk-free rate. Any difference between the actual return and the expected return must be due to new information unrelated to past prices (B). Therefore, choice B is correct.

When the Stock Price Follows a Random Walk,the Price Today