lecture06post

# lecture06post - Shostakovich The binomial model Lecture 6...

This preview shows pages 1–6. Sign up to view the full content.

Shostakovich The binomial model Lecture 6 - Binomial trees BUSI 588, Fall 2011 Diego Garc´ ıa Kenan-Flagler Business School UNC at Chapel Hill September 14th, 2011 c ± Diego Garc´ ıa, BUSI 588, Kenan-Flagler, Fall 2011 Lecture 6 - Binomial trees 1 / 20

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
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, Kenan-Flagler, 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: super-replication. 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, Kenan-Flagler, Fall 2011 Lecture 6 - Binomial trees 3 / 20

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Shostakovich The binomial model Last class Soul-searching: 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 risk-neutral probabilities) and discount at the risk-free rate. The risk-neutral probabilities did not have much to do with probabilities: they were (normalized) prices of “pure securities.” Risk-neutral pricing is isomorphic to pricing by arbitrage. In the background: replicating portfolio . Today we take this argument to more than one-period. c ± Diego Garc´ ıa, BUSI 588, Kenan-Flagler, Fall 2011 Lecture 6 - Binomial trees 4 / 20
Shostakovich The binomial model Shostakovich Stock follows binomial tree. Risk-free asset yielding 1% (per period). 100

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 20

lecture06post - Shostakovich The binomial model Lecture 6...

This preview shows document pages 1 - 6. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online