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Lecture_09 - 9 Contingent Claims Valuation-Theory A...

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1 9 Contingent Claims Valuation---Theory A Motivation The purpose of this chapter is to price interest rate options given the market prices of the entire zero-coupon bond price curve and its stochastic evolution. We do not ascertain whether these zero-coupon bond prices are correct relative to each other, as in arbitraging the yield curve. We therefore need to impose conditions on the zero-coupon bond price curve’s evolution, given the current market prices, so that it is arbitrage-free. Options are priced relative to this evolution.
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