As stochastic models are well suited for time-period analysis, they can be used to investigate historical data and its trends over a given period. This will give a fairly accurate picture of the risk/reward profile of an investment. The best part is that this system can be run from within your own computer and does not require any extra efforts on your part besides downloading and installing the software. Once you have it installed, all you need to do is type in historical data sets from your favourite stock/basket trade website and it will spit out a lot of useful details about the investments it found. It then lets you know how much and when to invest to protect your risk level.
In order to take my stochastic models for finance it, you first have to sign up to their website. They have a simple application that allows you to sign up with your details, such as email address and username. Once you are registered, you can then login and enter in your first and last name, country, date of birth, account provider and password. You will also be required to enter a credit card number. This step is optional, however if you choose to sign up for a free trial, you will be given an option of accessing the application through your credit card.
When choosing how you want to input your data into your portfolio, there are two main factors that you must take into consideration. The first factor is whether to use the stochastic or the random term methods. Both have their pros and cons, which you should investigate. There is also another factor that you must take into consideration before deciding which method you wish to use, this is whether your choice uses log or binomial models.
The main advantage of using stochastic models is that they are very flexible and can therefore be used in any market condition. However, their disadvantage lies in their inability to capture very long term trends and hence are unable to provide very accurate estimates. This can however be remedied by fitting a moving average filter to the data. The filter will take into account that the past is now past and only produce estimates for the future. Therefore it will smoothen out the range of prices and hence minimize the range of possible outcomes.
Another way in which I can take my stochastic models for finance and apply them to real world assets is to use a binomial model. This basically is a mathematical model which assumes that random events will occur randomly within the model and thus can be used to give probabilities and estimate outcomes. binomial models can be implemented to take my stochastic models for finance and implement it into a binomial portfolio.
A very powerful model that I recently learned about is the Rabin-Krueger (RK) distribution. This is also known as the exponential distribution due to its geometric shape. The benefit of learning about this form of stochastic models is that it can be fit into any existing financial model, and as it is so general, it is also easy to learn from. The drawback of this however is that it tends to over complicate the model and leads to overly simple outcomes. I’ll talk about this more in later articles.
Hopefully by now you have been able to see how stochastic models for portfolio management can help you with your investment projects. There are many other forms of stochastic models out there to consider, so if you have some time, why not take a look at some? Just remember to keep your portfolio diversified and stay motivated!