Comments on Unfair Value: In pursuit of certainty

You are not taking into account the effect of comp...

2008-11-17T22:54:00.000-08:00

You are not taking into account the effect of compounding.

years N=50
returns r=0.2 (20%)
probability of success p = 0.75 (75%)

For a large number N, you will succeed N*p times and fail n*(1-p) times

EndingValue = StartingValue * power(1+r,N * p)*power(1-2r,N*(1-p))

CAGR(%) = 100 * (power(power(1+r,N * p)*power(1-2r,N*(1-p)),1/N)-1)

So expected value does not give indication of the gains. A coin toss with 50% gain on success and 50% loss on failure has expected value zero but its a losing bet if played repeatedly.

The reason is
(1+r)*(1-r) = 1 - r*r

If you lose 50% of your investment this year, you won't be able to recover it by making 50% gains next year on the reduced capital.

Hope that answers your question.

Regards
Kamlesh

As per my calculations, the expected return in cas...

2008-11-17T09:24:00.000-08:00

As per my calculations, the expected return in case X is -0.6%, in case A is 5%, in case B is 6%, in case C is 8.4% and in case E is 8.7%. What am I doing wrong? (Example: Case A-> 75%*120 + 25%*60 = 105)

The rest of the post is strong even with the above calculations but the wrong calculations can bias one's understanding more strongly.

Wow some article. After reading this and the last ...

2008-11-16T18:03:00.000-08:00

Wow some article. After reading this and the last few articles I am really getting addicted and almost cant wait for the next one, just as i am addicted to Ajit Dayal's (equitymaster) articles.
The common thing between both of you is you speak truth and are honest. I am yet to come across articles/websites which speak the similar language. Cheers!