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Ex 10

The document provides exercises on option pricing theory in the Black-Scholes model. It asks the reader to (1) derive analytic expressions for the prices of various types of call options, including vanilla, cash-or-nothing, asset-or-nothing, and gap calls, using the Black-Scholes formula. It also asks the reader to (2) derive an expression for the evolution of a self-financing portfolio process using stochastic calculus.

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42 views2 pages

Ex 10

The document provides exercises on option pricing theory in the Black-Scholes model. It asks the reader to (1) derive analytic expressions for the prices of various types of call options, including vanilla, cash-or-nothing, asset-or-nothing, and gap calls, using the Black-Scholes formula. It also asks the reader to (2) derive an expression for the evolution of a self-financing portfolio process using stochastic calculus.

Uploaded by

AnuRagRedEye
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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ME302.

The Mathematical Foundations of the


Black & Scholes Option Pricing Theory
Exercises 10

1. We will see in the next lecture that, in the Black and Scholes model, the no arbitrage
price PtECC of a European contingent claim that yields the payoff F (ST ) at its maturity
time T > 0 is given by

PtECC = EQ e−r(T −t) F (ST ) | Ft , for t ∈ [0, T ],


 
(1)

where

dSt = rSt dt + σSt dWtϑ , (2)

and W ϑ is an (Ft )-Brownian motion under the risk-neutral probability measure Q.

(i) Provide an analytic expression for the price P0vanilla of a vanilla call that yields the
payoff

F (ST ) = (ST − K)+

at maturity T .
c/n
(ii) Provide an analytic expression for the price P0 of a cash-or-nothing call that
yields the payoff

F (ST ) = 1{ST >K}

at maturity T .
a/n
(iii) Provide an analytic expression for the price P0 of an asset-or nothing call option
that yields the payoff

F (ST ) = ST 1{ST >K}

at maturity T .
(iv) Provide an analytic expression for the price P0gap of a gap call option that yields
the payoff

F (ST ) = (ST − K)1{ST >K}

at maturity T .

1
s/s
(v) Provide an analytic expression for the price P0 of a super-share call that yields
the payoff
ST
F (ST ) = 1{K1 <ST <K2 }
K1
at maturity T .

2. In the Black and Scholes model, the evolution of a self-financing portfolio process (πt ) is
given by the stochastic differential equation

dXt = Xt rdt + πt (µ − r)dt + πt σdWt . (3)

Show that the solution to (3) is given by


 Z t Z t 
rt −ru −ru
Xt = e X0 + (µ − r) e πu du + σ e πu dWu .
0 0

Hint: Use (3) and apply integration by parts to Xt and Yt = e−rt .

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