1-11-7 - *Every time you add a time interval you add an outcome i.e shrinking the time interval increases the outcome Price

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Derivatives November 7 Binomial Model *Binomial is technically more accurate model *Black-Scholes uses lognormal distribution -is path dependent: company success is more likely to be followed by success and failure followed by failure *Binomial is sufficient: trinomial and quadnormial do not add significant value Probability up = p = a – d u – d a = e rh d = e -σ√h u = e σ√h h = Δt = time interval as % of the year -time interval is time between today and first binomial price Probability down = 1 – p *Nodes come from prior period price x u or d *Assumes a normal distribution
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Unformatted text preview: *Every time you add a time interval, you add an outcome: i.e. shrinking the time interval increases the outcome Price Comparison *Black-Scholes price = $1.70 *Binomial Price = $1.51 *Essay Question:-difference comes because we have too few time intervals-the “zero’s” are getting too much weight and attention *Expensing Options:-there is an argument that when companies vive executives stock options (call options) they should expense them-do some research and come up with an argument based on some logic...
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This note was uploaded on 12/21/2011 for the course SPEA V366 taught by Professor Aleksey during the Fall '11 term at UCSB.

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