10.1 Portfolios and Random Variables

Investors choose stocks on the basis of what they believe will happen. The decision of how to allocate money among the assets that form a portfolio depends on how one thinks the stocks will perform in the future. Random variables provide models for these possibilities, with one random variable representing each stock in the portfolio. This chapter concentrates on portfolios of two stocks and the role of dependence.

Two Random Variables

Let’s offer the day trader from Chapter 9 the opportunity to buy shares in two companies, IBM and Microsoft. For this example, we assume that a share of IBM or Microsoft stock costs $100 today. Two random variables describe how the values of these stocks change from day to day. ...

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