Despite being a source of great mirth, the discovery that highly paid equity analysts and fund managers can do no better than a monkey throwing darts at the stock tables is somewhat unfulfilling. The inability to beat the monkey is consistent with a random walk for stock prices and hence this has been adopted as one way to test market efficiency. [For those technically minded, a random walk process is one where the best estimate of tomorrow’s price of a non-dividend paying stock is today’s price.]
There are many discomforting features of equating the random walk with market efficiency. For one thing, many stocks pay dividends and so finding that these securities cannot reject the random walk diminishes the test. Theoretically, it has been shown that stocks should not follow random walks in any event. More broadly, if for some reason the price of a security deviates from its informationally efficient price it would be nice to know that there a market forces that bring weight to bear on that stock so as to force it back to fair value, which is a decidedly predictable dynamic known as mean reversion.
Which brings me to Gamestop. Yesterday, the US Securities and Exchange Commission published an analysis of the market microstructure conditions that contributed to a seemingly aenemic, possibly bankruptcy-destined old-economy retail store business attract so much market attention that it skyrocketed in both price and volume terms. The price rose from $5 to $364 at its peak, short-style hedge fund managers went broke, trading topped turnover lists for days and we all knew that this was a bubble that wasn’t going to end well for a lot of retail investors who, it seemed, were skylarking on Robinhood during a pandemic with nothing else to do. The SEC provides no major insights other than to wonder why the short-side arbitrage community gave up standing in front of the rocket ship. Market efficiency did not cross their brief.
So what does Gamestop’s price performance look like? You guessed it – it couldn’t be more like a random walk if it tried. Nine month’s after the seemingly irrational price bubble that should have exploded and come back to earth (mean reversion) the price continues to float around in the stratosphere at $186 per share with no obvious direction. This is precisely the behaviour of a random walk and consistent with market efficiency. Surely, however, one cannot conclude that the market for Gamestop is efficient in any shape or form. I venture to say that this is a test of the test of market efficiency and it fails dismally. If Gamestop follows a random walk then the random walk hypothesis has no value in telling us anything about market efficiency.
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