The Physics of Wall Street: a brief History of Predicting the Unpredictable

Primordial Seeds 
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ingly modern, and it seems Bachelier was essentially unprecedented 
in conceiving of the market in this way. And yet on some level, the 
idea seems crazy (perhaps explaining why no one else entertained it). 
Sure, you might say, I believe the mathematics. If stock prices move 
randomly, then the theory of random walks is well and good. But why 
would you ever assume that markets move randomly? Prices go up on 
good news; they go down on bad news. there’s nothing random about 
it. Bachelier’s basic assumption, that the likelihood of the price tick-
ing up at a given instant is always equal to the likelihood of its ticking 
down, is pure bunk.
this thought was not lost on Bachelier. As someone intimately fa-
miliar with the workings of the Paris exchange, Bachelier knew just 
how strong an effect information could have on the prices of securi-
ties. And looking backward from any instant in time, it is easy to point 
to good news or bad news and use it to explain how the market moves. 
But Bachelier was interested in understanding the probabilities of fu-
ture prices, where you don’t know what the news is going to be. Some 
future news might be predictable based on things that are already 
known. After all, gamblers are very good at setting odds on things like 
sports events and political elections — these can be thought of as pre-
dictions of the likelihoods of various outcomes to these chancy events. 
But how does this predictability factor into market behavior? Bach-
elier reasoned that any predictable events would already be reflected 
in the current price of a stock or bond. In other words, if you had 
reason to think that something would happen in the future that would 
ultimately make a share of Microsoft worth more — say, that Microsoft 
would invent a new kind of computer, or would win a major lawsuit
— you should be willing to pay more for that Microsoft stock now than 
someone who didn’t think good things would happen to Microsoft, 
since you have reason to expect the stock to go up. Information that 
makes positive future events seem likely pushes prices up now; infor-
mation that makes negative future events seem likely pushes prices 
down now.
But if this reasoning is right, Bachelier argued, then stock prices 
must be random. think of what happens when a trade is executed at a 
given price. this is where the rubber hits the road for a market. A trade 

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means that two people—a buyer and a seller—were able to agree on 
a price. Both buyer and seller have looked at the available information 
and have decided how much they think the stock is worth to them, but 
with an important caveat: the buyer, at least according to Bachelier’s 
logic, is buying the stock at that price because he or she thinks that in 
the future the price is likely to go up. the seller, meanwhile, is selling at 
that price because he or she thinks the price is more likely to go down. 
taking this argument one step further, if you have a market consisting 
of many informed investors who are constantly agreeing on the prices 
at which trades should occur, the current price of a stock can be in-
terpreted as the price that takes into account all possible information. 
It is the price at which there are just as many informed people willing 
to bet that the price will go up as are willing to bet that the price will 
go down. In other words, at any moment, the current price is the price 
at which all available information suggests that the probability of the 
stock ticking up and the probability of the stock ticking down are both 
50%. If markets work the way Bachelier argued they must, then the 
random walk hypothesis isn’t crazy at all. It’s a necessary part of what 
makes markets run.
this way of looking at markets is now known as the efficient market 
hypothesis. the basic idea is that market prices always reflect the true 
value of the thing being traded, because they incorporate all available 
information. Bachelier was the first to suggest it, but, as was true of 
many of his deepest insights into financial markets, few of his readers 
noted its importance. the efficient market hypothesis was later redis-
covered, to great fanfare, by University of chicago economist eugene 
fama, in 1965. nowadays, of course, the hypothesis is highly contro-
versial. Some economists, particularly members of the so-called chi-
cago School, cling to it as an essential and irrefutable truth. But you 
don’t have to think too hard to realize it’s a little fishy. for instance, 
one consequence of the hypothesis is that there can’t be any specu-
lative bubbles, because a bubble can occur only if the market price 
for something becomes unmoored from the thing’s actual value. Any-
one who remembers the dot-com boom and bust in the late nineties/
early 2000s, or anyone who has tried to sell a house since about 2006, 
knows that prices don’t behave as rationally as the chicago School 
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t h e p h y s i c s o f wa l l s t r e e t

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