Consilient Observer

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Februar 19, 2025

Probabilities and Payoffs: The Practicalities and Psychology of Expected Value

Februar 19, 2025

Probabilities and Payoffs: The Practicalities and Psychology of Expected Value

Consilient Observer

Probabilities and Payoffs: The Practicalities and Psychology of Expected Value

Februar 19, 2025

The prime task of an investor is to find opportunities with gaps between price and value, with price being fairly straightforward and value more of a challenge to assess.
A common approach to estimate value is to consider expected value, the sum of the products of various payoffs and their associated probabilities.
Some markets have seen a shift in appetite from high probability, low payoff opportunities to low probability, high payoff ones, including the trading of short-dated options in equity options markets.
In this report, we discuss some of the issues with the calculation of expected value, what the payoff picture means for investing, the implications of volatility drag, the psychology of dealing with probabilities and payoffs, and how these ideas can be helpful for investing in various asset classes.

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The views and opinions are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively the Firm”), and may not be reflected in all the strategies and products that the Firm offers.

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For the complete content and important disclosures, refer to the article pdf.

Probabilities and Payoffs: The Practicalities and Psychology of Expected Value