By Lars Kestner
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Example text
The term Brownian motion was largely unused until 1905, when a young scientist named Albert Einstein succeeded in analyzing the quantitative significance of Brownian motion. Despite the connection to Einstein’s and others’ work in the natural sciences, Bachelier’s paper, “Theorie de la Speculation,” went largely unnoticed for half a century. In the 1950s the study of finance began to rise in popularity as equities became a larger part of Americans’ investing behavior and academic research was performed in an attempt to detect the possible cyclical nature in stock prices.
Most traders have studied the efficient markets hypothesis, or EMH, which states that current prices reflect not only information contained in past prices, but also all information available publicly. In such efficient markets, some investors and traders will outperform and some will underperform, but all resulting performance will be due to luck rather than skill. The roots of the efficient markets hypothesis date back to the year 1900, when French doctoral student Louis Bachelier suggested that the market’s movements follow Brownian motion.
Quantitative traders were able to exploit profits. But as pricing systems improved and other traders noticed the inefficiency, these profit opportunities also disappeared. The constant theme throughout these stories is that traders with the best quantitative analysis are able to capitalize on market inefficiencies when they appear. Because these money-making opportunities do not last forever, traders must always continue research efforts to discover new techniques. Inefficiencies similar to those mentioned above do exist in the markets today, and we will attempt to identify these opportunities elsewhere in the book.