Peter Smith is a finance professor at a reputable university. One day, he was finally able to convince his wife to let him open an internet-based stock account. Given his training and knowledge on the stock markets, he was more than confident about his stock trading instincts and skills.

After the first few months of trading, he was frustrated with the fact that every time he thought a stock was going to make him money, it turned out to be a loser. Having recently learned about being contrarian, he decided to go against his instincts: he would buy stocks that he thought very negatively of, and short stocks that he thought very positively of.

A few more months later, he still found himself losing money. Well, he had tried ....

"I have a good theory that can explain the expected future return on every stock," says John to Joe.

"So, what is the expected one-year-forward return on IBM today?" Joe replies excitedly.

"Aaaaaaaaah .... I don't know and I cannot determine it. My theory can explain it, though. Once the expected IBM return is known, that is."

Last updated June 12, 1999.