Brownian Motion in Financial Markets
|Jørgen Veisdal||Aug 12, 2019|
If asset prices in the short term show an identifiable pattern, won’t speculators will find this pattern and exploit it, thereby eliminating it?
Brownian motion or pedesis is the term used in physics to describe the random motion of particles (such as specs of dust) suspended in a fluid (such as a liquid or gas) resulting from collisions of such particles with the fast-moving molecules of the fluid.
Although theorized as early as in 1827, it wouldn’t be until the publication of one of Einstein’s 1905 Annus Mirabilis papers that Brownian motion would rise to prominence as a useful theory for predicting naturally-occurring seemingly random phenomena. Five years before Einstein’s publication however, a French graduate student named Louis Bachalier had proposed a similar model as useful for predicting price changes in financial markets. The model now forms the basis of many if not most quantitative models of financial markets, including the now well-known Black-Scholes model. Continue reading