Introducing the Use of Markov Chain Model for Informed Decision Making for Investors in a Stock Market Environment

Gongsin Isaac Esbond, Fumilayo W. O. Saporu

Abstract: A 5-state Markov chain model is used to model the behaviour of daily stock price on the floor of the stock market. A simple test for the time homogeneity of the arising transition probability matrix is proposed. Criteria that can aid informed decisions on trading for short and long term investors are developed from the properties of the model. Its use is illustrated with data from Ecobank, Nigeria for short term investors. The results show that it is best to buy stock when price is at high depreciation state, and sell within two days when next the price rises to the high appreciation state. The use of these criteria is recommended.

Keywords: Markov Chain Model, Regular Markov Chain, Expected First Passage Times, Stock Exchange Price, Time Homogeneity Test, Fundamental Matrix