Model of the Behavior of stock Prices Chapter 11 Options, Futures, and Other Derivatives, 5th edition C 2002 by John C Hull
11.1 Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull Model of the Behavior of Stock Prices Chapter 11
11.2 Categorization of Stochastic Processes o Discrete time: discrete variable Discrete time continuous variable Continuous time discrete variable Continuous time continuous variable Options, Futures, and Other Derivatives, 5th edition C 2002 by John C Hull
11.2 Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull Categorization of Stochastic Processes • Discrete time; discrete variable • Discrete time; continuous variable • Continuous time; discrete variable • Continuous time; continuous variable
11.3 Modeling Stock Prices We can use any of the four types of stochastic processes to model stock prices The continuous time, continuous variable process proves to be the most useful for the purposes of valuing derivatives Options, Futures, and Other Derivatives, 5th edition C 2002 by John C Hull
11.3 Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull Modeling Stock Prices • We can use any of the four types of stochastic processes to model stock prices • The continuous time, continuous variable process proves to be the most useful for the purposes of valuing derivatives
11.4 Markov processes (See pages 216-7 e In a markov process future movements in a variable depend only on where we are, not the history of how we got where we are o We assume that stock prices follow Markov processes Options, Futures, and Other Derivatives, 5th edition C 2002 by John C Hull
11.4 Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull Markov Processes (See pages 216-7) • In a Markov process future movements in a variable depend only on where we are, not the history of how we got where we are • We assume that stock prices follow Markov processes
11.5 Weak-Form market Efficiency e This asserts that it is impossible to produce consistently superior returns with a trading rule based on the past history of stock prices. In other words technical analysis does not work e A Markov process for stock prices is clearly consistent with weak-form market efficiency Options, Futures, and Other Derivatives, 5th edition C 2002 by John C Hull
11.5 Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull Weak-Form Market Efficiency • This asserts that it is impossible to produce consistently superior returns with a trading rule based on the past history of stock prices. In other words technical analysis does not work. • A Markov process for stock prices is clearly consistent with weak-form market efficiency