Final answer:
The random walk hypothesis suggests that currency prices cannot be reliably predicted based on previous prices, but takes into account trends and beliefs that can impact future currency movements.
Step-by-step explanation:
The random walk hypothesis suggests that the best predictor of tomorrow's currency prices are today's prices. In this context, it means that the movement of currency prices follows a random pattern and cannot be reliably predicted based on previous prices. However, this hypothesis also takes into account the existence of a trend, which means that over time, currency prices tend to have a gradual upward or downward movement.
For example, if a country's currency is expected to strengthen in the future, investors may buy the currency, causing immediate appreciation. This can lead to further appreciation as other investors also believe in future appreciation. On the other hand, a fear that a currency will weaken can lead to an actual weakening of the currency, reinforcing the belief that it will weaken further.
Overall, while the random walk hypothesis suggests that currency prices cannot be predicted solely based on today's prices, it takes into account the influence of trends and beliefs that can impact future currency movements.