The discounted portfolio value of a selffinancing strategy in discrete time was given by. δ tj 1 (s tj s tj 1 ) (9.1) j=1
|
|
- Joleen Stokes
- 5 years ago
- Views:
Transcription
1 Chapter 9 The isk Neutral Pricing Measure for the Black-Scholes Model The discounted portfolio value of a selffinancing strategy in discrete time was given by v tk = v 0 + k δ tj (s tj s tj ) (9.) where v tk = e rt k Vtk is the discounted portfolio value at time t k = k t, k = 0,,..., N T = T/ t and s tk = e rt k Stk denotes the discounted asset price. Suppose that the price process S tk is given by a geometric Brownian motion such that s tk = e rt 2 k (µ S 0 e 2 )t k+x tk = S 0 e xt k +( 2 /2)t k =: s(x tk, t k ) (9.2) Suppose further that we have some european option with payoff H or discounted payoff h = e rt H where h = h(s tn ) or more generally h = h(s t0,..., S tn ), N = N T, and suppose that there is a replicating strategy such that δ tk = δ tk (S t,..., S tk ) (9.3) h = v tn = v 0 + Since v 0 = V 0, the price of the option, is a number, we can write v 0 = E v 0 = E h N δ tk (s tk s tk ) (9.4) k= N E δ tk (s tk s tk ) (9.5) k= where the expectation in (9.5) can be choosen arbitrarily. Let us consider (9.5) for the Wiener measure, dw ({x t } 0<t T ) = N T lim Π t 0 k= p t (x (k ) t, x k t ) dx k t (9.6) 65
2 66 Chapter 9 Because of Theorem 4. we have E W δk (s k s k ) = δ k (x t,..., x tk ) ( s(x tk, t k ) s(x tk, t k ) ) Π k p tj t j (x tj, x tj ) dx tj k ( = δ k (x t,..., x tk ) s(x, t tk k) p (x, x ) dx s(x tk tk tk tk tk tk k )), t k = ( δ k (x t,..., x tk ) E W s(xtk, t k ) x tk s(xtk, t k ) k k Π p tj t j (x tj, x tj ) dx tj ) k Π (9.7) p tj t j (x tj, x tj ) dx tj where we introduced the conditional expectation E W f({xs } 0 s T ) x t := f({x s }) dw ({x s } t<s T ) (9.8) with the obvious definition (t = N t t) dw ({x t } t<s T ) := lim N T Π t 0 j=n t+ p t (x (j ) t, x j t ) dx j t (9.9) In particular, if the function f in (9.8) depends only on a single x s, f = f(x s ), then f(x s ) if t s E W f(xs ) x t = (9.0) f(x s ) p s t (x t, x s ) dx s if t < s Let us compute the conditional expectation E W s(xtk, t k ) x tk in the last line of (9.7). We have, using t = t k t k E W s(xtk, t k ) x tk = s(x tk, t k ) p tk t k (x tk, x tk ) dx tk = t S 0 e xt k +( 2 /2)t k e (x tk x tk ) 2 2 t dx tk = S 0 e xt k +( 2 /2)t k = S 0 e xt k +( 2 /2)t k e 2 2 (t k t k ) e t y e y2 2 = s(x tk, t k ) e ()(t k t k ) (9.) Now, suppose the factor e ()(t k t k ) in (9.) would be absent. Then the round brackets in the third line of (9.7) would be zero for all k and the price of the option v 0 would be
3 Chapter 9 67 given by the expectation of the discounted payoff. Thus, we would be able to compute the price without knowing the hedging strategy, provided that there is a replicating strategy. Now, this factor is not absent but we can ask the following question: Is there some measure d W such that s(xtk, t k ) x tk = s(xtk, t k ) (9.2) If this is the case then we can compute the price v 0 of the option with discounted payoff h by taking the expectation value with respect to d W, v 0 = h (9.3) since the round brackets in the third line of (9.7) all vanish. There is the following Theorem 9.: Let s tk = s(x tk, t k ) be a discounted geometric Brownian motion given by (9.2). Define the kernels p t (x, y) = p µ,r, t (x, y) by Then: p t (x, y) := t e (x y t)2 2t (9.4) a) The kernels p satisfy p s (x, y) p t (y, z) = p s+t (x, z) (9.5) and p s(x, y) = for all x. That is, the measure is well defined. d W ({x t } 0<t T ) := lim N T Π t 0 k= p t (x (k ) t, x k t ) dx k t (9.6) b) The price process (9.2) is a martingale with respect to d W. That is, s(xt, t ) x t := s(x t, t ) d W ({x s } t<s T ) = s(x t, t) t < t (9.7) The measure d W is called an equivalenartingale measure (with respect to the price process s t ).
4 68 Chapter 9 Proof: a) Let p t (x, y) be the kernel (4.3). Then p t (x, y) = p t ( x t, y) ( = p t x, y + t) ( = p t x, y + ) 2 2 (9.8) such that, with Lemma 4., p s (x, y) p t (y, z) = p s ( x = p s+t ( x which proves part (a). Part (b) is obtained as (9.), s(xt, t ) x t = s(x t, t ) p t t(x t, x t ) dx t = (t t) s, y) ( p t y, z + t) s, z + t) = p s+t (x, z) (9.9) S 0 e x t +( 2 /2)t e (x t x t (t 2 t) ) 2(t t) dx t = S 0 e xt+( 2 /2)t e 2 2 (t t) e (x t (t t) = S 0 e xt+( 2 /2)t e 2 2 (t t) e t t y e y2 2 = S 0 e xt+( 2 /2)t xt+ (t t)) ( x t x t (t t)) 2 e 2(t t) dx t = s(x t, t) (9.20) This proves the theorem. In chapter 5 where we approximated the Black-Scholes model with a suitable Binomial model, we were able to prove the following pricing formula for some non path dependent option with payoff H = T ), see Theorem 5.2: V BS 0 = e rt H ( 2 (r S 0 e ) 2 )T + T x e x2 2 dx (9.2) Let us rederive (9.2) by using the equivalenartingale measure. Suppose we have a european option with discounted payoff h(s T ) = e rt T ) and that the namics of S is given by the Black-Scholes model with drift µ and volatility, S T = S 0 e x T +(µ 2 2 )T (9.22) Observe that the drift parameter µ does not show up in the pricing formula (9.2). This was actually a quite fundamental result of chapter 5. Here we will come up with the same conclusion:
5 Chapter 9 69 Let δ be the replicating strategy. Then N T v T = h(s T ) = v 0 + δ tk (s tk s tk ) (9.23) k= We fix some t = t k and take the expectation with respect to d W ({x s } t<s T ). This gives and we get h(st ) x t = v0 + k δ tj (s tj s tj ) = v tk = v t = e rt V t (9.24) V t = e rt h(st ) x t = e r(t t) H ( S 0 e ) x T +(µ 2 2 )T p T t (x t, x T ) dx T = e r(t t) = e r(t t) = e r(t t) = e r(t t) H ( S 0 e ) x T +(µ 2 2 )T e (x t x T (T t) ) 2 2(T t) dx T (T t) H ( S t e (x T x t)+()(t t) e 2 2 (T t) e r(t t)) e (x T x t + (T t) ) 2 H ( 2 y+(r S t e 2 )(T t)) e y2 2(T t) (T t) H ( S t e T t y+(r 2 2 )(T t)) e y2 2 2(T t) dx T (T t) (9.25) and, for t = 0, this coincides with (9.2). More generally, there holds the following Theorem 9.2: Let {x t } 0<t T be a Brownian motion and let t := S 0 e xt+(µ 2 2 )t (9.26) S (µ) Let dw be the Wiener measure and d W be the equivalenartingale measure. Then the following equality (µ) t ) = E W (r) t,..., S (r) ) (9.27) holds for all payoffs H = t,..., S tm ). In particular, the theoretical fair value V 0 = e rt (µ) t ) = e rt (r) E W t,..., S (r) ) (9.28)
6 70 Chapter 9 does not depend on the (usually not predictable) drift parameter µ, but depends only on the volatility parameter and the interest rate level r. Proof: From the definition of p we have (t 0 := 0) (µ) t ) = Because of m (µ) t ) m Π t + j t j (x t + j t j ) 2 (tj t j ) e x 2(t j t j ) dx tj S (µ) t = S (µ) t (x t ) = S 0 e xt+(µ 2 = S 0 e = S (r) t 2 )t 2 (xt+ t)+(r 2 )t (x t + t) (9.29) the statement follows from the substitution of variables y tj = x tj + t j.
In chapter 5, we approximated the Black-Scholes model
Chapter 7 The Black-Scholes Equation In chapter 5, we approximated the Black-Scholes model ds t /S t = µ dt + σ dx t 7.1) with a suitable Binomial model and were able to derive a pricing formula for option
More informationδ j 1 (S j S j 1 ) (2.3) j=1
Chapter The Binomial Model Let S be some tradable asset with prices and let S k = St k ), k = 0, 1,,....1) H = HS 0, S 1,..., S N 1, S N ).) be some option payoff with start date t 0 and end date or maturity
More informationA1: American Options in the Binomial Model
Appendix 1 A1: American Options in the Binomial Model So far we were dealing with options which can be excercised only at a fixed time, at their maturity date T. These are european options. In a complete
More information1 Implied Volatility from Local Volatility
Abstract We try to understand the Berestycki, Busca, and Florent () (BBF) result in the context of the work presented in Lectures and. Implied Volatility from Local Volatility. Current Plan as of March
More informationChange of Measure (Cameron-Martin-Girsanov Theorem)
Change of Measure Cameron-Martin-Girsanov Theorem Radon-Nikodym derivative: Taking again our intuition from the discrete world, we know that, in the context of option pricing, we need to price the claim
More informationAMH4 - ADVANCED OPTION PRICING. Contents
AMH4 - ADVANCED OPTION PRICING ANDREW TULLOCH Contents 1. Theory of Option Pricing 2 2. Black-Scholes PDE Method 4 3. Martingale method 4 4. Monte Carlo methods 5 4.1. Method of antithetic variances 5
More informationMASSACHUSETTS INSTITUTE OF TECHNOLOGY 6.265/15.070J Fall 2013 Lecture 19 11/20/2013. Applications of Ito calculus to finance
MASSACHUSETTS INSTITUTE OF TECHNOLOGY 6.265/15.7J Fall 213 Lecture 19 11/2/213 Applications of Ito calculus to finance Content. 1. Trading strategies 2. Black-Scholes option pricing formula 1 Security
More informationLévy models in finance
Lévy models in finance Ernesto Mordecki Universidad de la República, Montevideo, Uruguay PASI - Guanajuato - June 2010 Summary General aim: describe jummp modelling in finace through some relevant issues.
More informationθ(t ) = T f(0, T ) + σ2 T
1 Derivatives Pricing and Financial Modelling Andrew Cairns: room M3.08 E-mail: A.Cairns@ma.hw.ac.uk Tutorial 10 1. (Ho-Lee) Let X(T ) = T 0 W t dt. (a) What is the distribution of X(T )? (b) Find E[exp(
More informationFrom Discrete Time to Continuous Time Modeling
From Discrete Time to Continuous Time Modeling Prof. S. Jaimungal, Department of Statistics, University of Toronto 2004 Arrow-Debreu Securities 2004 Prof. S. Jaimungal 2 Consider a simple one-period economy
More informationStochastic Calculus, Application of Real Analysis in Finance
, Application of Real Analysis in Finance Workshop for Young Mathematicians in Korea Seungkyu Lee Pohang University of Science and Technology August 4th, 2010 Contents 1 BINOMIAL ASSET PRICING MODEL Contents
More informationLecture 17. The model is parametrized by the time period, δt, and three fixed constant parameters, v, σ and the riskless rate r.
Lecture 7 Overture to continuous models Before rigorously deriving the acclaimed Black-Scholes pricing formula for the value of a European option, we developed a substantial body of material, in continuous
More informationMASM006 UNIVERSITY OF EXETER SCHOOL OF ENGINEERING, COMPUTER SCIENCE AND MATHEMATICS MATHEMATICAL SCIENCES FINANCIAL MATHEMATICS.
MASM006 UNIVERSITY OF EXETER SCHOOL OF ENGINEERING, COMPUTER SCIENCE AND MATHEMATICS MATHEMATICAL SCIENCES FINANCIAL MATHEMATICS May/June 2006 Time allowed: 2 HOURS. Examiner: Dr N.P. Byott This is a CLOSED
More information1.1 Basic Financial Derivatives: Forward Contracts and Options
Chapter 1 Preliminaries 1.1 Basic Financial Derivatives: Forward Contracts and Options A derivative is a financial instrument whose value depends on the values of other, more basic underlying variables
More information1 Interest Based Instruments
1 Interest Based Instruments e.g., Bonds, forward rate agreements (FRA), and swaps. Note that the higher the credit risk, the higher the interest rate. Zero Rates: n year zero rate (or simply n-year zero)
More informationThe Black-Scholes PDE from Scratch
The Black-Scholes PDE from Scratch chris bemis November 27, 2006 0-0 Goal: Derive the Black-Scholes PDE To do this, we will need to: Come up with some dynamics for the stock returns Discuss Brownian motion
More informationEconomathematics. Problem Sheet 1. Zbigniew Palmowski. Ws 2 dw s = 1 t
Economathematics Problem Sheet 1 Zbigniew Palmowski 1. Calculate Ee X where X is a gaussian random variable with mean µ and volatility σ >.. Verify that where W is a Wiener process. Ws dw s = 1 3 W t 3
More informationMartingale Approach to Pricing and Hedging
Introduction and echniques Lecture 9 in Financial Mathematics UiO-SK451 Autumn 15 eacher:s. Ortiz-Latorre Martingale Approach to Pricing and Hedging 1 Risk Neutral Pricing Assume that we are in the basic
More informationSTOCHASTIC CALCULUS AND BLACK-SCHOLES MODEL
STOCHASTIC CALCULUS AND BLACK-SCHOLES MODEL YOUNGGEUN YOO Abstract. Ito s lemma is often used in Ito calculus to find the differentials of a stochastic process that depends on time. This paper will introduce
More informationChapter 14. The Multi-Underlying Black-Scholes Model and Correlation
Chapter 4 The Multi-Underlying Black-Scholes Model and Correlation So far we have discussed single asset options, the payoff function depended only on one underlying. Now we want to allow multiple underlyings.
More informationPricing theory of financial derivatives
Pricing theory of financial derivatives One-period securities model S denotes the price process {S(t) : t = 0, 1}, where S(t) = (S 1 (t) S 2 (t) S M (t)). Here, M is the number of securities. At t = 1,
More informationChapter 15: Jump Processes and Incomplete Markets. 1 Jumps as One Explanation of Incomplete Markets
Chapter 5: Jump Processes and Incomplete Markets Jumps as One Explanation of Incomplete Markets It is easy to argue that Brownian motion paths cannot model actual stock price movements properly in reality,
More information( ) since this is the benefit of buying the asset at the strike price rather
Review of some financial models for MAT 483 Parity and Other Option Relationships The basic parity relationship for European options with the same strike price and the same time to expiration is: C( KT
More information1 Geometric Brownian motion
Copyright c 05 by Karl Sigman Geometric Brownian motion Note that since BM can take on negative values, using it directly for modeling stock prices is questionable. There are other reasons too why BM is
More informationLecture 15: Exotic Options: Barriers
Lecture 15: Exotic Options: Barriers Dr. Hanqing Jin Mathematical Institute University of Oxford Lecture 15: Exotic Options: Barriers p. 1/10 Barrier features For any options with payoff ξ at exercise
More informationNon-semimartingales in finance
Non-semimartingales in finance Pricing and Hedging Options with Quadratic Variation Tommi Sottinen University of Vaasa 1st Northern Triangular Seminar 9-11 March 2009, Helsinki University of Technology
More informationLecture 11: Ito Calculus. Tuesday, October 23, 12
Lecture 11: Ito Calculus Continuous time models We start with the model from Chapter 3 log S j log S j 1 = µ t + p tz j Sum it over j: log S N log S 0 = NX µ t + NX p tzj j=1 j=1 Can we take the limit
More informationLecture 6: Option Pricing Using a One-step Binomial Tree. Thursday, September 12, 13
Lecture 6: Option Pricing Using a One-step Binomial Tree An over-simplified model with surprisingly general extensions a single time step from 0 to T two types of traded securities: stock S and a bond
More informationNEWCASTLE UNIVERSITY SCHOOL OF MATHEMATICS, STATISTICS & PHYSICS SEMESTER 1 SPECIMEN 2 MAS3904. Stochastic Financial Modelling. Time allowed: 2 hours
NEWCASTLE UNIVERSITY SCHOOL OF MATHEMATICS, STATISTICS & PHYSICS SEMESTER 1 SPECIMEN 2 Stochastic Financial Modelling Time allowed: 2 hours Candidates should attempt all questions. Marks for each question
More informationMAS452/MAS6052. MAS452/MAS Turn Over SCHOOL OF MATHEMATICS AND STATISTICS. Stochastic Processes and Financial Mathematics
t r t r2 r t SCHOOL OF MATHEMATICS AND STATISTICS Stochastic Processes and Financial Mathematics Spring Semester 2017 2018 3 hours t s s tt t q st s 1 r s r t r s rts t q st s r t r r t Please leave this
More informationBasic Arbitrage Theory KTH Tomas Björk
Basic Arbitrage Theory KTH 2010 Tomas Björk Tomas Björk, 2010 Contents 1. Mathematics recap. (Ch 10-12) 2. Recap of the martingale approach. (Ch 10-12) 3. Change of numeraire. (Ch 26) Björk,T. Arbitrage
More informationThe British Russian Option
The British Russian Option Kristoffer J Glover (Joint work with G. Peskir and F. Samee) School of Finance and Economics University of Technology, Sydney 25th June 2010 (6th World Congress of the BFS, Toronto)
More informationKing s College London
King s College London University Of London This paper is part of an examination of the College counting towards the award of a degree. Examinations are governed by the College Regulations under the authority
More information1 The continuous time limit
Derivative Securities, Courant Institute, Fall 2008 http://www.math.nyu.edu/faculty/goodman/teaching/derivsec08/index.html Jonathan Goodman and Keith Lewis Supplementary notes and comments, Section 3 1
More informationPath Dependent British Options
Path Dependent British Options Kristoffer J Glover (Joint work with G. Peskir and F. Samee) School of Finance and Economics University of Technology, Sydney 18th August 2009 (PDE & Mathematical Finance
More informationHomework Assignments
Homework Assignments Week 1 (p. 57) #4.1, 4., 4.3 Week (pp 58 6) #4.5, 4.6, 4.8(a), 4.13, 4.0, 4.6(b), 4.8, 4.31, 4.34 Week 3 (pp 15 19) #1.9, 1.1, 1.13, 1.15, 1.18 (pp 9 31) #.,.6,.9 Week 4 (pp 36 37)
More information1 Mathematics in a Pill 1.1 PROBABILITY SPACE AND RANDOM VARIABLES. A probability triple P consists of the following components:
1 Mathematics in a Pill The purpose of this chapter is to give a brief outline of the probability theory underlying the mathematics inside the book, and to introduce necessary notation and conventions
More informationPartial differential approach for continuous models. Closed form pricing formulas for discretely monitored models
Advanced Topics in Derivative Pricing Models Topic 3 - Derivatives with averaging style payoffs 3.1 Pricing models of Asian options Partial differential approach for continuous models Closed form pricing
More informationReplication strategies of derivatives under proportional transaction costs - An extension to the Boyle and Vorst model.
Replication strategies of derivatives under proportional transaction costs - An extension to the Boyle and Vorst model Henrik Brunlid September 16, 2005 Abstract When we introduce transaction costs
More informationAmerican Option Pricing Formula for Uncertain Financial Market
American Option Pricing Formula for Uncertain Financial Market Xiaowei Chen Uncertainty Theory Laboratory, Department of Mathematical Sciences Tsinghua University, Beijing 184, China chenxw7@mailstsinghuaeducn
More informationRisk Neutral Measures
CHPTER 4 Risk Neutral Measures Our aim in this section is to show how risk neutral measures can be used to price derivative securities. The key advantage is that under a risk neutral measure the discounted
More informationWe discussed last time how the Girsanov theorem allows us to reweight probability measures to change the drift in an SDE.
Risk Neutral Pricing Thursday, May 12, 2011 2:03 PM We discussed last time how the Girsanov theorem allows us to reweight probability measures to change the drift in an SDE. This is used to construct a
More informationThe Use of Importance Sampling to Speed Up Stochastic Volatility Simulations
The Use of Importance Sampling to Speed Up Stochastic Volatility Simulations Stan Stilger June 6, 1 Fouque and Tullie use importance sampling for variance reduction in stochastic volatility simulations.
More informationMATH3075/3975 FINANCIAL MATHEMATICS TUTORIAL PROBLEMS
MATH307/37 FINANCIAL MATHEMATICS TUTORIAL PROBLEMS School of Mathematics and Statistics Semester, 04 Tutorial problems should be used to test your mathematical skills and understanding of the lecture material.
More informationRisk Neutral Valuation
copyright 2012 Christian Fries 1 / 51 Risk Neutral Valuation Christian Fries Version 2.2 http://www.christian-fries.de/finmath April 19-20, 2012 copyright 2012 Christian Fries 2 / 51 Outline Notation Differential
More informationOption Pricing Models for European Options
Chapter 2 Option Pricing Models for European Options 2.1 Continuous-time Model: Black-Scholes Model 2.1.1 Black-Scholes Assumptions We list the assumptions that we make for most of this notes. 1. The underlying
More informationDr. Maddah ENMG 625 Financial Eng g II 10/16/06
Dr. Maddah ENMG 65 Financial Eng g II 10/16/06 Chapter 11 Models of Asset Dynamics () Random Walk A random process, z, is an additive process defined over times t 0, t 1,, t k, t k+1,, such that z( t )
More informationLecture: Continuous Time Finance Lecturer: o. Univ. Prof. Dr. phil. Helmut Strasser
Lecture: Continuous Time Finance Lecturer: o. Univ. Prof. Dr. phil. Helmut Strasser Part 1: Introduction Chapter 1: Review of discrete time finance Part 2: Stochastic analysis Chapter 2: Stochastic processes
More informationMathematics of Finance Final Preparation December 19. To be thoroughly prepared for the final exam, you should
Mathematics of Finance Final Preparation December 19 To be thoroughly prepared for the final exam, you should 1. know how to do the homework problems. 2. be able to provide (correct and complete!) definitions
More informationLast Time. Martingale inequalities Martingale convergence theorem Uniformly integrable martingales. Today s lecture: Sections 4.4.1, 5.
MATH136/STAT219 Lecture 21, November 12, 2008 p. 1/11 Last Time Martingale inequalities Martingale convergence theorem Uniformly integrable martingales Today s lecture: Sections 4.4.1, 5.3 MATH136/STAT219
More informationHow to hedge Asian options in fractional Black-Scholes model
How to hedge Asian options in fractional Black-Scholes model Heikki ikanmäki Jena, March 29, 211 Fractional Lévy processes 1/36 Outline of the talk 1. Introduction 2. Main results 3. Methodology 4. Conclusions
More informationStochastic Processes and Stochastic Calculus - 9 Complete and Incomplete Market Models
Stochastic Processes and Stochastic Calculus - 9 Complete and Incomplete Market Models Eni Musta Università degli studi di Pisa San Miniato - 16 September 2016 Overview 1 Self-financing portfolio 2 Complete
More informationBinomial model: numerical algorithm
Binomial model: numerical algorithm S / 0 C \ 0 S0 u / C \ 1,1 S0 d / S u 0 /, S u 3 0 / 3,3 C \ S0 u d /,1 S u 5 0 4 0 / C 5 5,5 max X S0 u,0 S u C \ 4 4,4 C \ 3 S u d / 0 3, C \ S u d 0 S u d 0 / C 4
More informationAdvanced Stochastic Processes.
Advanced Stochastic Processes. David Gamarnik LECTURE 16 Applications of Ito calculus to finance Lecture outline Trading strategies Black Scholes option pricing formula 16.1. Security price processes,
More information25857 Interest Rate Modelling
25857 UTS Business School University of Technology Sydney Chapter 20. Change of Numeraire May 15, 2014 1/36 Chapter 20. Change of Numeraire 1 The Radon-Nikodym Derivative 2 Option Pricing under Stochastic
More informationKing s College London
King s College London University Of London This paper is part of an examination of the College counting towards the award of a degree. Examinations are governed by the College Regulations under the authority
More information(1) Consider a European call option and a European put option on a nondividend-paying stock. You are given:
(1) Consider a European call option and a European put option on a nondividend-paying stock. You are given: (i) The current price of the stock is $60. (ii) The call option currently sells for $0.15 more
More informationFINANCIAL OPTION ANALYSIS HANDOUTS
FINANCIAL OPTION ANALYSIS HANDOUTS 1 2 FAIR PRICING There is a market for an object called S. The prevailing price today is S 0 = 100. At this price the object S can be bought or sold by anyone for any
More informationBrownian Motion and Ito s Lemma
Brownian Motion and Ito s Lemma 1 The Sharpe Ratio 2 The Risk-Neutral Process Brownian Motion and Ito s Lemma 1 The Sharpe Ratio 2 The Risk-Neutral Process The Sharpe Ratio Consider a portfolio of assets
More informationForwards and Futures. Chapter Basics of forwards and futures Forwards
Chapter 7 Forwards and Futures Copyright c 2008 2011 Hyeong In Choi, All rights reserved. 7.1 Basics of forwards and futures The financial assets typically stocks we have been dealing with so far are the
More informationModeling via Stochastic Processes in Finance
Modeling via Stochastic Processes in Finance Dimbinirina Ramarimbahoaka Department of Mathematics and Statistics University of Calgary AMAT 621 - Fall 2012 October 15, 2012 Question: What are appropriate
More informationRMSC 4005 Stochastic Calculus for Finance and Risk. 1 Exercises. (c) Let X = {X n } n=0 be a {F n }-supermartingale. Show that.
1. EXERCISES RMSC 45 Stochastic Calculus for Finance and Risk Exercises 1 Exercises 1. (a) Let X = {X n } n= be a {F n }-martingale. Show that E(X n ) = E(X ) n N (b) Let X = {X n } n= be a {F n }-submartingale.
More informationM5MF6. Advanced Methods in Derivatives Pricing
Course: Setter: M5MF6 Dr Antoine Jacquier MSc EXAMINATIONS IN MATHEMATICS AND FINANCE DEPARTMENT OF MATHEMATICS April 2016 M5MF6 Advanced Methods in Derivatives Pricing Setter s signature...........................................
More informationBasic Concepts in Mathematical Finance
Chapter 1 Basic Concepts in Mathematical Finance In this chapter, we give an overview of basic concepts in mathematical finance theory, and then explain those concepts in very simple cases, namely in the
More informationNumerical schemes for SDEs
Lecture 5 Numerical schemes for SDEs Lecture Notes by Jan Palczewski Computational Finance p. 1 A Stochastic Differential Equation (SDE) is an object of the following type dx t = a(t,x t )dt + b(t,x t
More informationAdvanced Topics in Derivative Pricing Models. Topic 4 - Variance products and volatility derivatives
Advanced Topics in Derivative Pricing Models Topic 4 - Variance products and volatility derivatives 4.1 Volatility trading and replication of variance swaps 4.2 Volatility swaps 4.3 Pricing of discrete
More informationFutures Options. The underlying of a futures option is a futures contract.
Futures Options The underlying of a futures option is a futures contract. Upon exercise, the option holder takes a position in the futures contract with a futures price equal to the option s strike price.
More informationS t d with probability (1 p), where
Stochastic Calculus Week 3 Topics: Towards Black-Scholes Stochastic Processes Brownian Motion Conditional Expectations Continuous-time Martingales Towards Black Scholes Suppose again that S t+δt equals
More informationStochastic Processes and Brownian Motion
A stochastic process Stochastic Processes X = { X(t) } Stochastic Processes and Brownian Motion is a time series of random variables. X(t) (or X t ) is a random variable for each time t and is usually
More informationReading: You should read Hull chapter 12 and perhaps the very first part of chapter 13.
FIN-40008 FINANCIAL INSTRUMENTS SPRING 2008 Asset Price Dynamics Introduction These notes give assumptions of asset price returns that are derived from the efficient markets hypothesis. Although a hypothesis,
More informationValuation of derivative assets Lecture 6
Valuation of derivative assets Lecture 6 Magnus Wiktorsson September 14, 2017 Magnus Wiktorsson L6 September 14, 2017 1 / 13 Feynman-Kac representation This is the link between a class of Partial Differential
More information1. 2 marks each True/False: briefly explain (no formal proofs/derivations are required for full mark).
The University of Toronto ACT460/STA2502 Stochastic Methods for Actuarial Science Fall 2016 Midterm Test You must show your steps or no marks will be awarded 1 Name Student # 1. 2 marks each True/False:
More informationB8.3 Week 2 summary 2018
S p VT u = f(su ) S T = S u V t =? S t S t e r(t t) 1 p VT d = f(sd ) S T = S d t T time Figure 1: Underlying asset price in a one-step binomial model B8.3 Week 2 summary 2018 The simplesodel for a random
More informationTHE MARTINGALE METHOD DEMYSTIFIED
THE MARTINGALE METHOD DEMYSTIFIED SIMON ELLERSGAARD NIELSEN Abstract. We consider the nitty gritty of the martingale approach to option pricing. These notes are largely based upon Björk s Arbitrage Theory
More informationArbitrage, Martingales, and Pricing Kernels
Arbitrage, Martingales, and Pricing Kernels Arbitrage, Martingales, and Pricing Kernels 1/ 36 Introduction A contingent claim s price process can be transformed into a martingale process by 1 Adjusting
More informationThe Black-Scholes Model
IEOR E4706: Foundations of Financial Engineering c 2016 by Martin Haugh The Black-Scholes Model In these notes we will use Itô s Lemma and a replicating argument to derive the famous Black-Scholes formula
More informationChapter 3: Black-Scholes Equation and Its Numerical Evaluation
Chapter 3: Black-Scholes Equation and Its Numerical Evaluation 3.1 Itô Integral 3.1.1 Convergence in the Mean and Stieltjes Integral Definition 3.1 (Convergence in the Mean) A sequence {X n } n ln of random
More informationProbability in Options Pricing
Probability in Options Pricing Mark Cohen and Luke Skon Kenyon College cohenmj@kenyon.edu December 14, 2012 Mark Cohen and Luke Skon (Kenyon college) Probability Presentation December 14, 2012 1 / 16 What
More informationOption Pricing. Chapter Discrete Time
Chapter 7 Option Pricing 7.1 Discrete Time In the next section we will discuss the Black Scholes formula. To prepare for that, we will consider the much simpler problem of pricing options when there are
More informationModule 10:Application of stochastic processes in areas like finance Lecture 36:Black-Scholes Model. Stochastic Differential Equation.
Stochastic Differential Equation Consider. Moreover partition the interval into and define, where. Now by Rieman Integral we know that, where. Moreover. Using the fundamentals mentioned above we can easily
More informationAnalysis of the sensitivity to discrete dividends : A new approach for pricing vanillas
Analysis of the sensitivity to discrete dividends : A new approach for pricing vanillas Arnaud Gocsei, Fouad Sahel 5 May 2010 Abstract The incorporation of a dividend yield in the classical option pricing
More informationAre stylized facts irrelevant in option-pricing?
Are stylized facts irrelevant in option-pricing? Kyiv, June 19-23, 2006 Tommi Sottinen, University of Helsinki Based on a joint work No-arbitrage pricing beyond semimartingales with C. Bender, Weierstrass
More informationAdvanced topics in continuous time finance
Based on readings of Prof. Kerry E. Back on the IAS in Vienna, October 21. Advanced topics in continuous time finance Mag. Martin Vonwald (martin@voni.at) November 21 Contents 1 Introduction 4 1.1 Martingale.....................................
More informationBinomial Model for Forward and Futures Options
Binomial Model for Forward and Futures Options Futures price behaves like a stock paying a continuous dividend yield of r. The futures price at time 0 is (p. 437) F = Se rt. From Lemma 10 (p. 275), the
More informationVolatility Smiles and Yield Frowns
Volatility Smiles and Yield Frowns Peter Carr NYU IFS, Chengdu, China, July 30, 2018 Peter Carr (NYU) Volatility Smiles and Yield Frowns 7/30/2018 1 / 35 Interest Rates and Volatility Practitioners and
More informationComputational Finance. Computational Finance p. 1
Computational Finance Computational Finance p. 1 Outline Binomial model: option pricing and optimal investment Monte Carlo techniques for pricing of options pricing of non-standard options improving accuracy
More informationLIBOR models, multi-curve extensions, and the pricing of callable structured derivatives
Weierstrass Institute for Applied Analysis and Stochastics LIBOR models, multi-curve extensions, and the pricing of callable structured derivatives John Schoenmakers 9th Summer School in Mathematical Finance
More informationLectures on Financial Mathematics. Harald Lang
Lectures on Financial Mathematics Harald Lang c Harald Lang, KTH Mathematics 2012 Preface Preface My main goal with this text is to present the mathematical modelling of financial markets in a mathematically
More informationResults for option pricing
Results for option pricing [o,v,b]=optimal(rand(1,100000 Estimators = 0.4619 0.4617 0.4618 0.4613 0.4619 o = 0.46151 % best linear combination (true value=0.46150 v = 1.1183e-005 %variance per uniform
More informationValuation of performance-dependent options in a Black- Scholes framework
Valuation of performance-dependent options in a Black- Scholes framework Thomas Gerstner, Markus Holtz Institut für Numerische Simulation, Universität Bonn, Germany Ralf Korn Fachbereich Mathematik, TU
More informationA Classical Approach to the Black-and-Scholes Formula and its Critiques, Discretization of the model - Ingmar Glauche
A Classical Approach to the Black-and-Scholes Formula and its Critiques, Discretization of the model - Ingmar Glauche Physics Department Duke University Durham, North Carolina 30th April 2001 3 1 Introduction
More informationA Continuity Correction under Jump-Diffusion Models with Applications in Finance
A Continuity Correction under Jump-Diffusion Models with Applications in Finance Cheng-Der Fuh 1, Sheng-Feng Luo 2 and Ju-Fang Yen 3 1 Institute of Statistical Science, Academia Sinica, and Graduate Institute
More informationIntroduction to Game-Theoretic Probability
Introduction to Game-Theoretic Probability Glenn Shafer Rutgers Business School January 28, 2002 The project: Replace measure theory with game theory. The game-theoretic strong law. Game-theoretic price
More informationTime-changed Brownian motion and option pricing
Time-changed Brownian motion and option pricing Peter Hieber Chair of Mathematical Finance, TU Munich 6th AMaMeF Warsaw, June 13th 2013 Partially joint with Marcos Escobar (RU Toronto), Matthias Scherer
More informationSolving the Black-Scholes Equation
Solving the Black-Scholes Equation An Undergraduate Introduction to Financial Mathematics J. Robert Buchanan 2014 Initial Value Problem for the European Call The main objective of this lesson is solving
More informationInvestment Guarantees Chapter 7. Investment Guarantees Chapter 7: Option Pricing Theory. Key Exam Topics in This Lesson.
Investment Guarantees Chapter 7 Investment Guarantees Chapter 7: Option Pricing Theory Mary Hardy (2003) Video By: J. Eddie Smith, IV, FSA, MAAA Investment Guarantees Chapter 7 1 / 15 Key Exam Topics in
More informationIntroduction to Affine Processes. Applications to Mathematical Finance
and Its Applications to Mathematical Finance Department of Mathematical Science, KAIST Workshop for Young Mathematicians in Korea, 2010 Outline Motivation 1 Motivation 2 Preliminary : Stochastic Calculus
More informationStructural Models of Credit Risk and Some Applications
Structural Models of Credit Risk and Some Applications Albert Cohen Actuarial Science Program Department of Mathematics Department of Statistics and Probability albert@math.msu.edu August 29, 2018 Outline
More informationA Brief Review of Derivatives Pricing & Hedging
IEOR E4602: Quantitative Risk Management Spring 2016 c 2016 by Martin Haugh A Brief Review of Derivatives Pricing & Hedging In these notes we briefly describe the martingale approach to the pricing of
More informationThe Birth of Financial Bubbles
The Birth of Financial Bubbles Philip Protter, Cornell University Finance and Related Mathematical Statistics Issues Kyoto Based on work with R. Jarrow and K. Shimbo September 3-6, 2008 Famous bubbles
More information