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Unformatted text preview: ∆ t (Figure 18.1, page 392 ) Su Sd S p 1 – 3 4 RiskNeutral Valuation To determine the value of the option, we construct a riskless hedged portfolio. We choose the tree parameters (p, u, and d) so that the tree gives the correct values for the mean and standard deviation of the stock price changes in a riskneutral world. In a riskneutral world, everyone is indifferent to risk so that all assets earn the riskfree rate. We value the option based on the idea that the expected return should be the riskfree interest rate. 5...
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 Spring '12
 LucyAckert
 Probability theory, Binomial Trees

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