First-order auto regressive process specifies

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i) Why has it seemed reasonable, from the standpoint of financial theory, that stock prices are approximately a Random Walk? Does the theory suggest a Random Walk is more likely than an AR-1 process (First-Order Auto regressive Process specifies that the output variable depends linearly on its own previous values) ? Explain.

ii) The old investing adage “don’t put all your eggs in one basket” sounds very simple: Don’t put your entire portfolio in one stock. But, is the mean-variance portfolio theory of Markowitz (1952) that we have learned during class so simple? Does the portfolio theory suggest putting one share of each stock in one’s portfolio? What kinds of factors does the theory imply that one must consider, and why?

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