American Finance Association

On the Behavior of Stock Price Relatives as a Random Process with an Application to New
York Stock Exchange Prices
Author(s): Bruce D. Fielitz
Source: The Journal of Finance, Vol. 25, No. 3 (Jun., 1970), pp. 694-695
Published by: Wiley for the American Finance Association
Stable URL: http://www.jstor.org/stable/2325871
Accessed: 07-06-2017 13:15 UTC

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 ON THE BEHAVIOR OF STOCK PRICE RELATIVES AS A RANDOM
PROCESS WITH AN APPLICATION TO NEW YORK STOCK
EXCHANGE PRICES*

BRUCE D. FIELITZ
University of Oklahoma

THIS STUDY EVALUATES stock-price movements as a random process, employing the

Markovian probabilistic model to explain changes in the natural logarithms of stock-
price relatives.
A typical stock-market observer is faced with the problem of predicting the future
behavior either of the market or of a particular stock. By utilizing Markov-chain
models, this dissertation analyzes the behavior both of a population of stocks and of
individual stocks over a period of time, for the explicit purpose of learning how to
predict future price behavior wholly on the basis of past price information.
There are two ways of looking at the problem. One can study the individual-
process Markov-chain model, or one can consider the vector-process Markov chain.
The individual-process Markov chain allows one to study the change behavior of
each individual stock, while the vector-process Markov chain considers not only the
individual processes describing particular stocks, but also the process that charac-
terizes the stock market as a whole. In the vector-process Markov-chain model, the
processes for each component stock are themselves considered as Markov chains.
The set of states for the individual-process Markov chain is defined by first testing
the stationarity of the individual sample records, and then applying the stable
Paretian distribution as the form of the distribution of the random variable in
the process. Previous research has shown that the stable Paretian distribution
generally has an infinite variance, and thus the mean absolute deviation (which is
not infinite) is used in this paper as a measure of dispersion rather than the variance.
Together with the mean value, these parameters are employed to define the set of
states for a three-state Markov chain.
Once the set of states is defined, it is possible to obtain the empirical initial and
transition probabilities. The standard statistical tests for independence and station-
arity in Markov chains are immediately applicable.
The vector-process Markov-chain model is considered next and the same method
for defining the states used in connection with the individual process is applicable
here. However, one major problem usually encountered in considering a vector
Markov-chain model is the lack of homogeneity in the system (which is not the same
as stationarity of the process, but refers to the property that in a vector process
each of the individual processes has the same theoretical transition probabilities),
and a test for this property is developed. Also, standard statistical methods for
testing independence and stationarity in the case of the vector Markov chain are
described.
The individual-process and vector-process Markov-chain models are examined
empirically using a sample of 200 stocks from the New York Stock Exchange for the
period, December 23, 1963 through November 29, 1968. Both fixed-time and
variable-time price data (in the form of closing and high prices) are employed for

* A dissertation completed at Kent State University in 1969.

694

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 Abstracts of Doctoral Dissertations 695

these 200 stocks, and two different time lags-daily and weekly-are also considered.
In all, eight different cases were analyzed using a Burroughs 5500 computer.
The results for the individual-process Markov-chain model indicate that there is
little difference in the outcome of tests of fixed-time and variable-time individual-
process Markov-chain models. However, there is considerable difference between the
results for daily and weekly relatives. Specifically, it appears that while the stock
market has a short-term memory as far as daily price relatives are concerned, this
dependence does not carry over to weekly relatives. Further, the Markov chains for
daily closing and high price relatives are found to be nonstationary, and therefore
cannot be used for predictive purposes. When weekly closing and high price relatives
are considered, the process becomes independent in time, and the question of pre-
dicting future (weekly) behavior does not arise.
In addition to conclusions reached in reference to the individual-process Markov-
chain models, the results of the empirical analysis also show that because of heteroge-
neity the vector Markov chain cannot be used to analyze stock-price movements as
a whole.

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