SOCR EduMaterials Activities ApplicationsActivities StockSimulation
From Socr
A Model for Stock prices
- Description: You can access the stock simulation applet at http://www.socr.ucla.edu/htmls/app/ .
- Process for Stock Prices: Assumed a drift rate equal to μS where μ is the expected return of the stock, and variance σ^{2}S^{2} where σ^{2} is the variance of the return of the stock. From Weiner process the model for stock prices is:
or
Therefore
S Price of the stock.
ΔS Change in the stock price.
Δt Small interval of time.
ε Follows N(0,1).
- Example: The current price of a stock is . The expected return is μ = 0.10 per year, and the standard deviation of the return is σ = 0.20 (also per year).
- Find an expression for the process of the stock.
- Find the distribution of the change in S divided by S at the end of the first year. That is, find the distribution of .
- Divide the year in weekly intervals and find the distribution of at the end of each weekly interval.
- Therefore, sampling from this distribution we can simulate the path of the stock. The price of the stock at the end of the first interval will be S_{1} = S_{0} + ΔS_{1}, where ΔS_{1} is the change during the first time interval, etc.
- Using the SOCR applet we will simulate the stock's path by dividing one year into small intervals each one of length of a year, when , annual mean and standard deviation: μ = 0.14,σ = 0.20.
- The applet will select a random sample of 100 observations from N(0,1) and will compute
Suppose that ε_{1} = 0.58. Then
Therefore
ΔS_{1} = S_{0} + ΔS_{1} = 20 + 0.26 = 20.26.
We continue in the same fashion until we reach the end of the year. Here is the SOCR applet.