StochasticProcesses Describes the way in which a variable suchas a stock price, exchange rate or interestrate changes through timeIncorporates uncertainties
Stochastic Processes Describes the way in which a variable such as a stock price, exchange rate or interest rate changes through time Incorporates uncertainties
Example1Each day a stockprice increases by $1 with probability 30% stays the same with probability 50% reduces by $1 with probability 20%
Example 1 Each day a stock price increases by $1 with probability 30% stays the same with probability 50% reduces by $1 with probability 20%
Example2 Each day a stock price change is drawn froma normal distribution with mean so.2 andstandard deviation $1
Example 2 Each day a stock price change is drawn from a normal distribution with mean $0.2 and standard deviation $1
MarkovProcesses (Seepages 280-81)In a Markov process future movements in avariable depend only on where we are, notthe history of how we got to where we areIs the process followed by the temperatureat a certain place Markov?Weassume that stock pricesfollowMarkovprocesses
Markov Processes (See pages 280-81) In a Markov process future movements in a variable depend only on where we are, not the history of how we got to where we are Is the process followed by the temperature at a certain place Markov? We assume that stock prices follow Markov processes
Weak-Form Market EfficiencyThis asserts that it is impossible toproduce consistently superior returns witha trading rule based on the past history ofstock prices. In other words technicalanalysis does not work.AMarkovprocessforstockprices isconsistent with weak-form marketefficiency
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 consistent with weak-form market efficiency