Predictiing the Market Index

Risk Aversion-Return on equity method for estimating Market equilibrium

If one is given a choice of doubling their bet with 70 % probability or getting the money back with 30% probability and another proposition where one has 50% chance of  getting 30% bet or loosing his bet otherwise, choosing the former is called Risk aversion a la Von Nuemann-Morgenstein.

Now consider the Stock Market prices fluctuate enigmatically as without having any underlying reasons. The causation can be analyzed as follows.

Suppose if one graph the time on the X-axis and Risk and Return (2graphs) on the Y-axis, the return graph is exponentially rising and the risk graph exponentially declining like the demand/supply curve only difference is here it is exponential curves rising and falling.. The risk can be taken as the t-bill returns and return the return on equity for practical purposes.

The point of intersection of both curves is the short term equilibrium of the market which can be used to calculate the prices of Stock or the Indices. If one connect using a chord the end points of the exponential curves passing through the equilibrium points one gets the parabola. The risk curve can shift right ward or left according to changes in money supply of the economy or interest rates or other policy changes.

The shift in equilibrium can thus give new equilibrium levels which can be predicted.

A time series can be developed using the time series expansion of “e” and daily market price can be predicted.

I have studied the Indian stock market for the past 12 days and found that on the 7^th day the market hit the predicted value then it degenerated from the trajectory and now is 173 points away from the predicted end of day value. This is due to anomalous and restrictive government regulations. One can use this to predict if the government and market regulations are on dot. In India now if interest rates are reduced then the equilibrium can be reached but the inflation has started picking up so I think the Regulators are in a wedge and markets will have to live in confusion and side ways movement for time being. Moreover environment is restrictive to modern business practices and welfare is seldom given to citizen which again increases the systemic risk. Moreover I feel in the long run the market will hit the equilibrium after volatility where the equilibrium moves around.

American stock market equilibrium can be studied like this