Stock returns must be a martingale after compensating investors for risk

Evidence

In a randomwalk model, he pointed out, the average return on stocks probably had to be “sweeter” than the rate of interest that could be earned from “riskless securities,” for otherwise risk-averse investors could not be persuaded to hold stocks at all (Samuelson n.d., p. 11). However, after allowing for that “fair return,” stock-price changes had to be a “fair game” or what mathematicians call a “martingale,” because “if everyone could `know’ that a stock would rise in price, it would already be bid up in price to make that impossible.” In consequence, “it is not easy to get rich in Las Vegas, at Churchill Downs, or at the local Merrill Lynch office.” — Donald MacKenzie, An Engine, Not a Camera, 289

Categorization

• DEFINE: Introduces the martingale/fair-game concept central to the efficient markets literature, with the intuition that no predictable profit can exist.