Links to all tutorial articles (same as those on the Exam pages)Stochastic processes
Stochastic processes
In finance and risk, you will always be running into what are called 'stochastic processes'. Well, that is just a more complex way of saying that a variable is random. A variable is considered 'stochastic' when its value is uncertain. In finance, security returns are usually considered stochastic. In this brief article , we look at some key concepts relating to stochastic variables, including the geometric Brownian motion process (borrowed from particle physics) which is often used to model asset returns. Some terms to know:
Behavior of future prices:
Now a little bit more about returns and prices: Therefore: Change in price = Expected return + Number drawn randomly from a standard normal distribution, Or Δp = μ + ϕ(0, σ), where Δp is the change in price, μ is the expected return (as a percentage of the stock price), ϕ is a drawing from the normal distribution and σ is the standard deviation of the expected return. Also, if P is the current price, then the future price P1 is given by:
