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Stock Market Prices Do Not Follow Random Walks

turingfinance.com

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Re: Stock Market Prices Do Not Follow Random Walks

#2

Post by nickff »

This post is quite interesting, and I will have to re-read and ponder it some more, but there is one obvious flaw in the analysis. By analyzing the past returns of current S&P500 companies, the author is allowing for survivorship bias; companies which have done consistently well (in terms of market capitalization) over the analysis period are likely to be over-represented in current indices. To correct for this, the author should re-run the analysis using the S&P500 companies from the beginning of the period instead of the end.

This is the same problem that a study ran into some time ago when it demonstrated that the portfolio managers with the worst returns were the best investments; it analysed the returns of a number of managers over a period and found that the ones with the worst returns at the beginning had the best returns at the end. The problem is that all the consistently mediocre or bad managers were discarded, as they did not survive until the end of the period.

Re: Stock Market Prices Do Not Follow Random Walks

#3

Post by Flarbengaber »

nickff wrote: post #2

This post is quite interesting, and I will have to re-read and ponder it some more, but there is one obvious flaw in the analysis. By analyzing the past returns of current S&P500 companies, the author is allowing for survivorship bias; companies which have done consistently well (in terms of market capitalization) over the analysis period are likely to be over-represented in current indices. To correct for this, the…

I didn't quite understand your last paragraph, but it sounds interesting. Do you have a link?

Re: Stock Market Prices Do Not Follow Random Walks

#4

Post by amazing_jose »

Flarbengaber wrote: post #3
nickff wrote: post #2

This post is quite interesting, and I will have to re-read and ponder it some more, but there is one obvious flaw in the analysis. By analyzing the past returns of current S&P500 companies, the author is allowing for survivorship bias; companies which have done consistently well (in terms of market capitalization) over the analysis period are likely to be over-represented in current indices. To correct for this, the…

I didn't quite understand your last paragraph, but it sounds interesting. Do you have a link?

I think he means that lucky strikes can be longer than the career span of many managers. You never see them losing because they don't live long enough to have a devastating return to the average.

Re: Stock Market Prices Do Not Follow Random Walks

#5

Post by moosinho »

Flarbengaber wrote: post #3
nickff wrote: post #2

This post is quite interesting, and I will have to re-read and ponder it some more, but there is one obvious flaw in the analysis. By analyzing the past returns of current S&P500 companies, the author is allowing for survivorship bias; companies which have done consistently well (in terms of market capitalization) over the analysis period are likely to be over-represented in current indices. To correct for this, the…

I didn't quite understand your last paragraph, but it sounds interesting. Do you have a link?

If you enjoy reading about human biases coming from non-statistical point of view then check out "Thinking fast and slow" by Kahneman. Great read.

Re: Stock Market Prices Do Not Follow Random Walks

#7

Post by gjm11 »

Flarbengaber wrote: post #3
nickff wrote: post #2

This post is quite interesting, and I will have to re-read and ponder it some more, but there is one obvious flaw in the analysis. By analyzing the past returns of current S&P500 companies, the author is allowing for survivorship bias; companies which have done consistently well (in terms of market capitalization) over the analysis period are likely to be over-represented in current indices. To correct for this, the…

I didn't quite understand your last paragraph, but it sounds interesting. Do you have a link?

Toy model: A fund can do well or badly at the start of the period, and it can do well or badly at the end. Both happen completely at random. A fund that does badly at both ends is closed and never heard from again.

If you analyse funds in this situation, you will find that every fund that does badly at the start of the period does well at the end. (Because the ones that do badly at the end too are all gone.) You might be tempted to think up clever explanations about how fund managers with bad initial results make extra effort, or how stocks that do badly tend to rebound later as investors recognize their true value, or something -- but that would be a mistake, because in this situation the only thing leading to the relationship between early and late performance is the fact that the "bad at both ends" funds aren't represented in the analysis.

Re: Stock Market Prices Do Not Follow Random Walks

#9

Post by SixSigma »

tiatia wrote: post #8

I did not read the link but Benoit Mandelbrot basically showed this 30 years ago. So what's the news?

Computer scientists do not stand on the shoulder of giants, they slay them, grind them up and then do all the work again.

> You want to make your way in the CS field? Simple. Calculate rough time of amnesia (hell, 10 years is plenty, probably 10 months is plenty), go to the dusty archives, dig out something fun, and go for it. It's worked for many people, and it can work for you. -- Ron Minnich

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