A random walk goes nowhere in particular. Thus the theme of this section, which doesn’t have one.
But “Random Walk” is also an important statistical concept. The phrase was coined by mathematician Karl Pearson (1857–1936), father of the modern discipline of statistics. And cursed be his name by all business majors being frog-marched through required courses in Statistics. (Pearson, the SOB, also invented the Standard Deviation.)
All “Random Walk” really means is that you have a formula or algebraical process the outcome of which is completely random. This turns out to be a surprisingly difficult thing to do in mathematics. (Just as it turns out to be a surprisingly easy thing to do in life.) A jollier term for it is “Drunken Walk,” and all business majors who’ve managed to pass Statistics should treat themselves to one.
In economics the Random Walk is a key element of the “Efficient Market Theory” or “EMT.” EMT asserts that the price of an asset (the usual example is a publically traded stock) reflects all the information available about the intrinsic value of that asset.
Therefore every asset is always “correctly priced” at any given time. And, because new information about the asset will be randomly favorable or unfavorable to the value of the asset, future changes of price will be a Random Walk and therefore impossible to predict.
In other words, if you’re trying to figure out whether the stock market will go up or down, you’re fucked.
Unless you’re a genius and have an original way—that nobody else knows—of analyzing all the information available about the intrinsic value of an asset. You’re not a genius. You’re fucked.
With one exception. Efficient Market Theory fails to allow for the possibility that you are a liar, a thief, and a fraud. You may have presented information about an asset that’s not true. You may be concealing “insider trading” information that you should have publically disclosed. You may be Bernie Madoff.
So, what EMT and Random Walk teach us is that the more honest you are, the less you know about what’s going to happen next in business and economics.
And this makes me a really honest guy.