Scribd
Upload
67 views2 pages

CompFin 2020 SS QF Sheet 04

This document contains exercises from a computational finance course. Exercise 10 asks students to derive the parameters u, d, and q for a binomial model where the condition S(0)u^M d^M = K replaces the standard condition u = d^1. Exercise 11 asks students to write a function to price a European call option in this altered binomial model and compare the results to the standard binomial model and Black-Scholes formula. Exercise 12 asks students to represent the process for the exchange rate of the Euro in US dollars as an Itō process. Exercise 13 asks students to construct an arbitrage in a market with three assets following given stochastic processes. Exercise 14 is a bonus problem asking students to show a given process

Uploaded by

7 RODY
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
67 views2 pages

CompFin 2020 SS QF Sheet 04

This document contains exercises from a computational finance course. Exercise 10 asks students to derive the parameters u, d, and q for a binomial model where the condition S(0)u^M d^M = K replaces the standard condition u = d^1. Exercise 11 asks students to write a function to price a European call option in this altered binomial model and compare the results to the standard binomial model and Black-Scholes formula. Exercise 12 asks students to represent the process for the exchange rate of the Euro in US dollars as an Itō process. Exercise 13 asks students to construct an arbitrage in a market with three assets following given stochastic processes. Exercise 14 is a bonus problem asking students to show a given process

Uploaded by

7 RODY
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 2

Christian-Albrechts-Universität zu Kiel SS 2020

Mathematisches Seminar
Prof. Dr. Sören Christensen
Adrian Theopold, Henrik Valett Sheet 04

Computational Finance
Exercises for all participants

T-Exercise 10 (2 points)
In the course we fixed the relation u = d1 in the specification of the binomial model that
is used as an approximation to the Black-Scholes model. For even M ∈ N, this implies
M M
S(0)u 2 d 2 = S(0). Replace the condition (1.3), i.e. u = d1 , by
M M
S(0)u 2 d 2 = K.

Your task is to show to show the following:


 2/M −1 +α exp(σ 2 δ )
K
Setting (this will ease your computation) α = exp(r∆t ), γ = S(0) and β = γα 2
t

we get the following result for the parameters u, d, q:


q
u = β + β 2 − γ,
q
d = β − β 2 − γ,
α −d
q= .
u−d

C-Exercise 11 (2 points)
We want to price a European call option that is deep out of the money with strike price K > 0
using the binomial model where condition (1.3) is replaced by
M M
S(0)u 2 d 2 = K.

Write a function

V_0 = CRR_EuCall_altcond (S_0, r, sigma, T, M, K)

that computes and returns an approximation to the price of an European call option with
strike K > 0 and maturity T > 0 in the Black-Scholes model with initial stock price S(0) > 0,
interest rate r > 0 and volatility σ > 0 using the CRR-model with the altered condition and
M ∈ N time steps.

We now want to compare the new method to the old one and to the true price in the BS-model.
To this end also write a function that calculates the price of a European call with the original
conditions from the lecture notes and in addition implement the BS-Formula for call options.
Compare the results by plotting the error of each approximation against the BS-price in a
common graph. Use the following parameters

S(0) = 100, r = 0.03, σ = 0.3, T = 1, M = 100, K = range(70, 200).


T-Exercise 12 (Exchange rates) (4 points)
Assume that the exchange rate D(t) of the US-Dollar in Euro at time t > 0 follows the
equation
dD(t) = D(t)µdt + D(t)σ dW (t)
with D(0) > 0 and µ, σ ∈ R. Hence, the exchange rate of the Euro in US-Dollar at time
1
t > 0 is given by E(t) := D(t) . Represent the process E as Itō process, i.e. in the form

dE(t) = . . . dt + . . . dW (t).

Interpret your result economically in the case µ = 12 σ 2 .

T-Exercise 13 (4 points)
Let W1 , W2 be independent standard Brownian motions. Consider a market with three assets
S0 , S1 , S2 , which follow the equations

S0 (t) = 1,
dS1 (t) = S1 (t) (3dt + dW1 (t) − dW2 (t)) ,
dS2 (t) = S2 (t) (1dt − dW1 (t) + dW2 (t)) .

Construct an arbitrage in this market.

T-Exercise 14 (4 bonus points, this exercise is not mandatory)


Let W be a standard Brownian motion. Show that the process
 Z t 
1
X(t) := E (W ) (t) 1 + ds , t ∈ R+ ,
0 E (W ) (s)

solves the stochastic differential equation

dX(t) = 1dt + X(t)dW (t), X(0) = 1.

Please comment your solution. Please include your name(s) as comment in the beginning
of the file.

Submit until: Thu, 14.05.2020, 8:30

You might also like