Problem 2 Reconsider Problem 1. Suppose now that whether or not the stock goes up tomorrow...

Problem 2

Reconsider Problem 1. Suppose now that whether or not the stock goes up tomorrow depends upon whether it increased today, yesterday, and the day before yesterday.

a) Can this problem be formulated as a Markov chain?

b) If so, what and how many are the possible states?

c) Explain why these states (the ones defined in part b) give the process the Markovian property whereas the states in Problem 1 do not (for this problem).

Problem 1

Whether the stock goes up tomorrow depends upon whether it increased today and yesterday. If the stock increased today and yesterday, it will decrease tomorrow with probability α1. If the stock increased today and decreased yesterday, it will decrease tomorrow with probability α2. If the stock decreased today and increased yesterday, it will decrease tomorrow with probability α3. Finally, if the stock decreased today and yesterday, it will decrease tomorrow with probability α4

Expert Solution

orchestra answered 1 year ago

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