Alternating Up and Down Moves
A stock starts at price . It then falls , rises , falls , rises , and so on forever, alternating. What value does the price converge to?
Work it out, then compare with the answer.
SolutionShow the worked solution
Each fall multiplies the price by and each rise by . A fall followed by a rise therefore multiplies it by
Let be the price after moves. Then
Both subsequences tend to geometrically, since , so the whole sequence does too. The price never actually reaches zero, but it falls below any positive level eventually. For example, it halves after about pairs of moves.
Key idea. Equal percentage moves up and down do not cancel. Their product is , so alternating gains and losses of the same size steadily erode the value. This effect is called volatility drag.
Generalisation. With alternating moves of for , the price after moves is .