14.3 THE PROCESS FOR A STOCK PRICE
In this section we discuss the stochastic process usually assumed for the price of a non-dividend-paying stock.
It is tempting to suggest that a stock price follows a generalized Wiener process; that is, that it has a constant expected drift rate and a constant variance rate. However, this model fails to capture a key aspect of stock prices. This is that the expected percentage return required by investors from a stock is independent of the stock’s price. If investors require a 14% per annum expected return when the stock price is $10, then, ceteris paribus, they will also require a 14% per annum expected return when it is $50.
Clearly, the assumption of constant expected drift rate is inappropriate and needs ...
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