A Stochastic Model Approach to Study the Demeanor of Financial Markets and Impact of COVID-19 Pandemic on Spot and Forward Rates

Abstract

This study explores the possibility of applying Discrete Time Markov Chain to predict the behaviour of financial markets, to obtain their steady state probabilities, and to apply Markov chains to predict the business cycle. The basic terminologies of Markov chain, as well as a brief introduction about mathematical finance are presented. The classifications of future markets and various types of business risks have also been analysed. The spot and forward rates were observed through a real data considered from the State Bank of India, before and after the impact of the novel Corona Virus (COVID-19), and analysed. Markov models will provide the best solution to deal the current situation. By using Markov models, one can approximately predict the future behaviour of the economic situations of financial markets. This study implies that every investor should make careful examination before investing in the financial market to minimise the risk, considering the impact of the contagious disease COVID-19.

Keywords: Markov Chain, Steady State, Financial Markets, Business Cycle, Spot Rates, Forward Rates, COVID-19

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