[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

can expect to earn only a normal level of profit. Of course, the trick is to know when
to sell stocks before everyone else also decides it is time to sell. In 2000, the prices
of technology stocks dropped dramatically. Today, shares of Microsoft trade for
around $27 each.
The one exception is not really an exception because it involves trading with
knowledge that other stock market participants do not have. Inside traders are individuals
who buy and sell shares of companies for which they work. Studies show
that their inside knowledge does in fact enable them to obtain above-average returns.
Federal law requires inside traders to disclose when they buy and sell shares in their
own company. People who may not have the inside knowledge but imitate the stock
market behavior of the insiders also do slightly above average. The law also restricts
the ability of insiders to share their information with outsiders and profit from their
extra knowledge, and it exacts penalties for violations. After Ivan Boesky made
untold millions trading on insider information in the 1980s, he paid large fines and
even served time in jail. More recently, Martha Stewart spent five months in jail for
obstructing an investigation into possible insider trading.
Because prices in an efficient market already reflect all available information,
any price changes are a response to unanticipated news. If it was already known that
something good was going to occur—for instance, that some new computer model
better than all previous computers was going to be unveiled—the price of the firm’s
stock would reflect this knowledge (it would be high) before the computer actually
hit the market. Investors might not know precisely how much better than its competitors
the new computer was, and hence they could not predict precisely by how
much future earnings were likely to rise. They would make an estimate. The market
will reflect the average of these estimates. When the new computer is introduced,
there is some chance that it will be better than this average, in which case the price
will rise further. But there is also a chance that it will not be quite as good as this
average estimate, in which case the price will fall, even though the computer is in
fact better than anything else on the market. In the latter case, the “surprise” is that
the computer is not as good as the market anticipated.
Since tomorrow’s news is, by definition, unanticipated, no one can predict whether
it will cause the stock price to rise or to fall. In an efficient stock market, prices will
move unpredictably, depending on unexpected news. When a stock has an equal
chance of rising or falling in value relative to the market as a whole, economists say
that its price moves like a random walk. Figure 39.6 shows a computer-generated
random walk, giving an idea of how unpredictable such a path is.
The phrase random walk conjures up the image of a drunk who rambles down
the street with generally unstable—and unpredictable—movements. So too with
the stock market. Although the level of all stock prices drifts upward, whether any
particular stock will do better or worse than that average is unpredictable. If the
stock market is indeed a random walk, it is virtually impossible for investors to beat
the market. You can do just as well by throwing darts at the newspaper financial
page as you can by carefully studying the prospects of each firm. The only way to do
better than the market, on average, is to take greater risks; but taking greater risks
also betters your chance of doing worse than the market.
The randomness of the market has one important consequence: some individuals
are going to be successful. This is bad news for people who want to
EFFICIENT MARKET THEORY ∂ 883