Stock Exchange and Probability
Why do we have to study Probability? One of the simplest answers is that there are no such certain things on planet Earth. Everything that happens around us all has incidence and occurrence, so we all have to study probability to at least have an instinct of whether things around us will likely happen or not.
So why probability is important in the stock market? Imagine you are going to invest in my company, Company A, the probability of Company A’s stock rising post-earnings announcement is 60%. So if you buy the stock, there is 60% that you will make some profits and 40% that you make a loss.
There is a famous stock model that was designed in 1973 by 2 economists, Black and Scholes who later received Nobel prizes for their achievements. For beginners like me 🙂, there are some preliminary problems that I want to share with you to have a wider view of this field:
So first there needs to be some assumptions:
-
Assume the unit of time is days
-
Every time a stock rises or falls only 1 unit
-
Assume the probability that stock rises is p -> the probability that a stock falls is 1-p.
So here are the questions?
What is the probability so that:
-
After N days, the stock price is still the same
-
After N days, the stock price increases “x” unit
-
After N days, the stock price decreases “x” unit
