Mauvais Sort

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Mauvais Sort
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Gambling vs. investing

• Expected return
• Pi probability that outcome i happens
• Ri Return when outcome i happens
• C investment costs
• N outcomes
• Probabilities add up to 1
• Expected Return S Pi Ri - C

N
i1
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Gambling vs. investing

• Fair bet Expected return is zero
• Coin flip Pay C 1 to play
• Heads Receive R1 2, P1 .5
• Tails Receive R2 0, P2 .5
• Expected Return P1R1 P2 R2 - C
• .52 .50 - 1 0

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Gambling

• Unfair bet
• Gambler Expected return lt0
• Casino Expected return gt0
• Slot machines pay 92 per bet
• Expected return for customer -8
• Expected return for Casino 8

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Gambling

• Unfair bet
• Lottery
• Expected return for customer -50/
• Expected return for Lottery 50/

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Gambling

• Cards, Horses
• Gambler Expected return depends on skill
• Casino Expected return gt0 on average or else
  they rent the space (poker)
• Casinos will not offer games that have negative
  expected return to the Casino

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What proportion of ISU college students gamble?

• Overall 56
• Males 61
• Females 49
• Gamblers spent
• 64 lt 20/month
• 18 20-60/month
• 18 gt 60/month
• Average 33 per month

T. Hira and K. Monson. A social learning
perspective of gambling among college students
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Why do ISU students gamble?

• Entertainment 65
• To win money 30
• Women more likely to say for entertainment
• Men more likely to say to win

T. Hira and K. Monson. A social learning
perspective of gambling among college students
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Investments

• Positive Expected Return
• Risk Expected Return has an expected variance
• Past returns are no guarantee
• of future returns
• Tradeoff between expected return and risk

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Role of Risk in pricing assetsSuppose threat of
terrorist attack increases, expected earnings
stream remains unchanged
S, of shares
P0
D, low risk period
P1
D, high risk period
As Stock Price falls, (PS / E) (1/r) decreases,
and so implied yield r rises
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(No Transcript)
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Always Positive (almost)
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11 periods of negative returns in the last 39
years
1933
InvestorsFriend.com  http//www.investorsfriend.co
m/Historical20Total20Nominal20and20Real20Retu
rns20on20Stocks20(SP2050020Index).htm
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10 periods of negative returns in the last 39
years
1933
InvestorsFriend.com  http//www.investorsfriend.co
m/Historical20Total20Nominal20and20Real20Retu
rns20on20Stocks20(SP2050020Index).htm
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13 periods of negative real returns in the last
39 years
1933
InvestorsFriend.com  http//www.investorsfriend.co
m/Historical20Total20Nominal20and20Real20Retu
rns20on20Stocks20(SP2050020Index).htm
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(No Transcript)
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Annual returns after inflation, taxes and
expenses
Stocks
Differences in taxes also affect long run returns
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How can you take advantage of higher expected
returns and lower risk?
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Diversification

• Holding several assets can lower risk without
  sacrificing return

The mixed portfolio yields higher utilitysame
expected return, lower variance
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Mutual Funds

• Financial intermediary holds a portfolio of
  stock.
• Individual investors buy shares of the portfolio

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Another Diversification Mechanism

• Holding assets over a long period can lower risk
• Higher average return wins out

Warren Buffet Asked when is the best time to
sell stockNever
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Holding Periods and Large Firm Stock Returns,
1926-2005 Period Best Worst 1 54 (1933)
-43 (1931) 5 29 (1995-99) -12
(1928-32) 10 20 (1949-58) -1
(1929-38) 20 18 (1980-99) 3
(1929-48) ______________________________ Ibbotson
Associates, 2006
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Percentage of Times Stocks Have Outperformed
Government Bonds, by Holding Period Period
(Yrs) 1802-1997 1926-2005 1 61 61 5 70
75 10 80 89 20 91 98 30 99 100
________________ Ibbotson Associates, 1998, 2006
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A third way to diversify Dollar cost averaging
invest regularly In down periods, cost per share
is low, in up periods, get return
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1950-2009