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A Random Walk Down Wallstreet - A Commentary

Commentary on Chapter 1 and 8 of the book "A Random Walk Down Wallstreet". This is a Financial Management Cuurse Assignment

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Dicky Irawan
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241 views19 pages

A Random Walk Down Wallstreet - A Commentary

Commentary on Chapter 1 and 8 of the book "A Random Walk Down Wallstreet". This is a Financial Management Cuurse Assignment

Uploaded by

Dicky Irawan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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A Random

Walk Down
Wall Street
(a commentary by Group 1)
The book and The author

● Written by Professor Burton Gordon


Malkiel, publication in 1973
● American economist, financial executive,
and writer, born in August 1932
● On the subject of stock markets which
popularized the “random walk” hypothesis
● Stock prices follow a random pattern and
are not predictable in the short term
Chapter 1
Firm Foundations and
Castles in the Air
UNDERSTANDING THE RANDOM WALK THEORY

What is Random Walk?


● stock prices move in a random, unpredictable pattern.
● Prices reflect all current information, and changes are random
and influenced by unforeseen events.
Implications for Investors
● Impossible to predict short-term movements in stock prices.
● Stock prices do not follow patterns; past movements do not
predict future directions.
INVESTING AS A WAY OF LIFE TODAY

Investors play the long game, carefully choosing assets with a chance of steady growth
over time, even if the risk is moderate. Speculators, however, chase quick wins by
buying riskier assets that could soar in value but also vanish completely.

“Investing requires work, make no mistake about it.”


Burton G. Malkiel
INVESTING IN THEORY

Perfect future prediction is


impossible; all investments
depend on future events, which
are inherently uncertain

It is critical to know what your goals and


objectives are. Whether it be to fund retirement,
purchase a home, or undertake a new business
venture, knowing what you're working towards
will help you choose an investment to help you
meet your goals.
“All investment returns, whether from common stocks or exceptional
diamonds, are dependent, to varying degrees, on future events.”
Burton G. Malkiel
THE FIRM-FOUNDATION THEORY

Intrinsic Value - When market prices fall down, a


buying or selling opportunity arises.
The theory of investment value advocates
determining a stock's intrinsic value and using
discounting to achieve this.
Discounting involves considering future income
in present terms, look at the money expected in
the future and see how much less it is currently
worth.
The firm-foundation theory offers a logical
framework for valuing investments. However,
the challenge lies in accurately determining The success of investors like Warren Buffet
intrinsic value, which relies heavily on future doesn't necessarily prove the theory is
universally applicable. Their skill and
predictions. experience likely play a significant role.
CASTLE IN THE AIR THEORY

“An asset is only worth what someone else will pay for it”

No asset has an “intrinsic value” that can be determined analytically or


mathematically; rather, the value of an asset is purely
psychological—it’s worth whatever the majority of investors think it’s
worth.
● A castle-in-the-air investor makes money by investing in stocks they thinks other
investors will value.
● Their work is not to estimate intrinsic values, but rather analyze how the crowd of
investors is likely to behave in the future and how they tend to build their dreams:
on castles in the air and selling stock to the ‘greater fool’.
HOW THE RANDOM WALK IS TO BE CONDUCTED

With the firm-foundation theory, the problem is its reliance on future estimates. No
analyst can know for certain how much or how long a stock’s dividends will grow—or
even if they’ll grow at all.

With the castle-in-the-air theory, the challenge is timing. The successful castle-in-the-air
investor needs to buy an asset just before mass enthusiasm causes its price to rise (and
sell before that enthusiasm wanes).

a “random walk” or a compromise between these two


ideas, can offer a more accurate depiction of how
markets operate.
Chapter 8
A new Walking Shoe:
Modern Portfolio Theory
EFFICIENT-MARKET HYPOTHESIS

● The Efficient-Market Hypothesis (EMH) proposes that financial markets reflect


all available information, making it impossible for investors to consistently
outperform the market through stock selection or timing.
● According to EMH, stock prices adjust rapidly to
new information, leaving no room for investors to
gain an advantage based on past information.
● This suggests that predicting the future course of the
market or selecting superior stocks is akin to a
random walk, where outcomes are unpredictable.
DEFINING RISK: The Dispersion of Returns

The possibility of suffering harm or loss.

Investment risk is the Risk is often quantified by


likelihood that expected measures such as variance
security returns may not or standard deviation of
materialize, leading to losses returns
or lower-than-expected
returns.

While risk is often associated with potential losses, it is also the source of returns in
the investment world. To address risk, he emphasizes the importance of
diversification, which is a central theme of MPT
DOCUMENTING RISK: A Long - Run Study

● One of the best-documented


propositions in the field of
finance is that, on average,
investors have received higher
rates of return for bearing
greater risk.
● However, there are ways in
which investors can reduce
risk. This brings us to the
subject of modern portfolio
theory.
REDUCING RISK: Modern Portfolio Theory (MPT)
● To lower investment volatility, investors can adopt a less
volatile investment or a counter investment for their
portfolio.
● Modern Portfolio theory (MPT) is a framework for
understanding how investors can construct optimal
portfolios that balance risk and return.
● It is based on 2 assumptions that investors are rational and
risk-averse
● Diversify their portfolios by combining different assets that
have different risk-return characteristics

Modern portfolio in my opinion is good for a company use or


those with a lot of money and require a certain amount of returns
to be attractive. Younger generations tend to have less amount of
capital and adapt to different strategies. So, it’s ok to invest small
amounts you can contribute to for a return when its starts to
move in favor.
DIVERSIFICATION IN PRACTICE

“Is there a point at which


diversification is no longer
a magic wand
safeguarding returns?”
CORRELATION COEFFICIENT

“As long as there is some lack of parallelism in the


fortunes of the individual companies in the economy,
diversification can reduce risk.”
KEY TAKEAWAY

“Globalization led to an
increase in the correlation
coefficients between the
U.S. and foreign markets
as well as between stocks
and commodities”
“Diversification cannot eliminate all risk because all stocks
tend to move up and down together. Thus, diversification
in practice reduces some but not all risk.”
Burton G. Malkiel
Thank you!
Khang - Samuel - Dicky - Christian - Minh - Anthony - Veren - Nuchanart

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