The Maximum-Entropy Distribution of the Future Market Price of a Stock

John M. Cozzolino and Michael J. Zahner
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John M. Cozzolino: University of Pennsylvania, Philadelphia, Pennsylvania
Michael J. Zahner: Sun Services Corporation, Philadelphia, Pennsylvania

Operations Research, 1973, vol. 21, issue 6, 1200-1211

Abstract: This paper uses the principle of maximum entropy to construct a probability distribution of future stock price for a hypothetical investor having specified expectations. The result obtained is in good agreement with observations recorded in the literature. Thus, the paper concludes that the hypothetical individual investor is representative of a large class of investors. This new derivation of the well known random-walk theory of stock-price movements leads to an improved understanding of the model parameters by relating the variance of the random-walk process to the risk aversion of the investors. A practical use of the model is proposed to help the investor form an objective opinion of his skill.

Date: 1973
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Persistent link: https://EconPapers.repec.org/RePEc:inm:oropre:v:21:y:1973:i:6:p:1200-1211

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