This preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
Unformatted text preview: Shostakovich The binomial model Lecture 6  Binomial trees BUSI 588, Fall 2011 Diego Garc´ ıa KenanFlagler Business School UNC at Chapel Hill September 14th, 2011 c Diego Garc´ ıa, BUSI 588, KenanFlagler, Fall 2011 Lecture 6  Binomial trees 1 / 20 Shostakovich The binomial model Outline and handouts 1 Shostakovich Valuation Replication 2 The binomial model The magic Assumptions and calibration Handouts today: Class slides and case 6 solutions (Shostakovich). Homework 2 solutions. Announcements: We are done with concepts at some point next week  then mostly applications. c Diego Garc´ ıa, BUSI 588, KenanFlagler, Fall 2011 Lecture 6  Binomial trees 2 / 20 Shostakovich The binomial model Homework 2 highlights Problems 1 and 2: “busy work,” make sure everyone knows how to price forwards and calls in a one period binomial. Problem 3: forward pricing meets reality. Costs of storage, convenience yields. The theory just cannot fit natural gas  it is not possible to store it. Problem 4: can do Bachelier with your eyes closed. Problem 5: being more precise with expected returns on derivatives relative to the underlying asset. Problem 6: superreplication. Portfolio that dominates cash flows of derivative provides upper bound. Portfolio that is dominated by cash flows of derivative provides lower bound. c Diego Garc´ ıa, BUSI 588, KenanFlagler, Fall 2011 Lecture 6  Binomial trees 3 / 20 Shostakovich The binomial model Last class Soulsearching: In a binomial world we can price assets using the formula V X = ˆ p u X u + ˆ p d X d 1 + r f ; take expected value (using riskneutral probabilities) and discount at the riskfree rate. The riskneutral probabilities did not have much to do with probabilities: they were (normalized) prices of “pure securities.” Riskneutral pricing is isomorphic to pricing by arbitrage. In the background: replicating portfolio . Today we take this argument to more than oneperiod. c Diego Garc´ ıa, BUSI 588, KenanFlagler, Fall 2011 Lecture 6  Binomial trees 4 / 20 Shostakovich The binomial model Shostakovich Stock follows binomial tree. Riskfree asset yielding 1% (per period)....
View
Full Document
 Fall '10
 Staff
 Business, Derivatives, Real options analysis, Mathematical finance, Shostakovich, Diego Garc´ BUSI

Click to edit the document details