Wednesday, March 01, 2006

Efficient Markets and Stock Price

Q: Consider a stock that has an equal chance of being $27, $33, or $36 on, say, June 1st. What do you expect the price of the stock to be today?

A: To an approximation, an approximation which is sufficient for the purposes of this class, you can say that the price of the stock today must be equal to the expected future value. So the current price would be $33. This of course ignores the discounting that should take place from now until June 1st, and it doesn't incorporate a premium for uncertainty, but it is fine as an approximation.


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