Consider a one-period binomial model with initial stock price So, up factor u, down factor...
70.2K
Verified Solution
Link Copied!
Question
Finance
Consider a one-period binomial model with initial stock price So, up factor u, down factor d, initial bond price Ag, bond return r, up probability p, and terminal time T. Assume that the market satisfies the principle of no-arbitrage. In addition to the risky stock and the riskless bond, let us consider a derivative security written on the stock, that is, its payoff Dy is given as a function of the stock price Sy at time T: Dr = f(ST), where f: [0, +00) + R is a function. Hence, if the stock price goes up at time T', then the payoff is DT f(US), and if the stock price goes down, then Dt = f(ds.). (For instance, f (t) = (K )+ for a put option with strike price K.) a. (5) Does there exist a replicating portfolio for this derivative? If yes, then find all such portfolios. b. (5) Let (2, y) be a replicating portfolio for this derivative. Using the principle of no-arbitrage, show that its price is given by Do = 3:So + yAn. c. (5) Show that D. can be written as 1 DO (qf (So) + (1 - 9)f(dSo), 1+r for some 0
Answer & Explanation
Solved by verified expert
Get Answers to Unlimited Questions
Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!
Membership Benefits:
Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!
