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L 3 Extra

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Bogdan Carauleanu
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65 views8 pages

L 3 Extra

Uploaded by

Bogdan Carauleanu
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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6cem388 - LecTuRE 3 LAST TIME \ TODAY RISK-NEUTRAL PROB, COMPLETE MARKETS LONG /SHORT POSITION PROBABILITY Review HEDGING A (HORT) POSITION RANDOM VARIABLE S MULTI-PERIOD MODEL PRos. DISTRIB. \ CwealTH EQN) | \_ expectation STOCHASTIC PROCESS eee (NO ARBITRAGE ) | A RINANCIAL MARKET 1S COMPLETE Ie ANY DERIVATIVE CAN BE REPLICATED BY TRADING IN THE UNDERLTING stock AND BANK Cie. #PAVOFE =F cmantnl Baki. Se. See! TH l22: le THE MARKET \S ComPLETE , THEN 4HE PRICE OF ANY DERIVATIVE is UNIQUE UNIQUE. (THERE \S NO ARBITRAGE ) SAMPLE SPACE 1%) =SET OF ALL POSSIBLE CHTEOMES Event A = sueseT OF 2 PROB. MEASURE P = FUNCTION THAT ASSOCIATES TO EACH POSSIBLE OUTCOME wedl& A NUMBER BETWEEN O AND 4: PH)IETM!N , ST TI Powel wed PRo®. OF EVENT A > PrAy= DL Pew) Prog @F VERT A = wer MUTUALLY ExcLusive Events A AND By aAns= OTE (uo COMMON OUTCOMES) IN THAT CASE: P(AUB) = PCA) +PUB). INDEPENDENT EVENTS A AND B? PIAQB) = PA) PIB) eSrSh SSS a (ANOTHER EVENT CONSISTING DF ALL OUTCOMES = UNION OF EVENTS A AND B Tuat ARE EITHER IN A, OR IN B, OR IN BoTH) Yana = INTERSECTION OF EVENTS A AND B. A ree et ete THAT ARE IN_BOTH A ANT B) Aeoa |= comPLEMENT OF A (ser OF oUuTCOmMES IN ty wHicH ARE NoT IN A) AUS ANB Pe noe: PODaO. eEM=k, PI —I1-PCA). FINITE PROB. SPACE Qu = FINITE SAMPLE SPACE P = prom. MEASURE (3°? comPponENT NOT REBU RED HERE) * xy a : RANDOM VARIA®LE = SUNCTION THAT ASSOCIATES RANDOM VA To EACH OUTCOME weSL & REAL NUMBER tw) eS SS lw) O Ki WTR DENOTE §=—- P(AW3D = PW) Sev POINT rae - PR. 2 > COAT (Coney WORKS FOR DISCRETE CASE ) Examele EXPERIMENT + TOSS 4 COIN SAMPLE SPACE: WSU= 3HiT3 EVENT A= {HEADS COME UPS = 3H} CSL=SHITS POH =p s POarTay = 5 pega EVENTS =4H\, Belt} ARE MUTUALLY Exclusive inpee 2? P(ANBI= P(D)=O 7 P(A)-P(B) FO = P(AnB) # PLA) PLB) =? NOT INDEP, IF HOWIN AA IE T LOSE RL DENOTE Y= WINNINGS => x(We4 J w= a xtere 4" fe a ue aX, K Tye -L yest Key is Const. FUNCTION = RN, prog. DisTRiB. OF RV. X= FUNCTION THAT SHOWS HOW! Se THe PROB. (400%) IS DISTRIBUTED AMONG THE POSSIBLE VALUES OF XX ft Ee; Z a si) w 8 4 TTS ee) a possiBle VALUES OF sy EG: toss A FAIR COIN 3 TIMES, START WHITH £2. FoR GACH TOSS DOUBLE YouR MONEY IF H, OR Lose dd IE T. LET X=FINAL WEALTH. PROB. DISTRIB. OF X 7 ‘ PossiBLE VALUES e<> i oF x i. S163 \ ~{ PCXE-AD= PU we: Xwie-48) = PG TTT) = seek INDEP =P Geasriasry) INO PLATS) P(MTS) PUTS) = at EG. DIFFERENT DISTRIB. UNDER DIFFERENT PROBS. Koped XCT)sk 4 Pst PcT)= 4 ReAL-worLd Prog aT ; 3 2 \ Pi< 7 > Pin=4 RISK NEUTRAL PROB UNDER ro) i UNDER 2) VALUES | PRO® * DIFFERENT WiticH PROB. 15 PREFERAGLE HERE ? EXPECTATION OF A_RN. LFIRST MOMENT) ee eee cee Q: WHAT DO WIE EXPECT ON AVERAGE THE VALUE OF x To Be ? leT K BE A RN. ON A FINITE PROB. SPACE (-2.P) THE EXPECTES VALUE oF KX CDENOCTED E)) elie evaeaee secs 1S A NUMBER: EQ\Y = 3S) (wd P(e) wesy EG. FAIR COIN, X(H)=4, X(T =-L Eon = EG XtwrPw) = XCD POH) + CTI PIT = ESF ED4 &laX+b1) =a&G+bECr) FoR VARIANCE » VAR(a XK) = & VAR(X) TIF XY INDER RV. THEN © VAR(@X+bY) = of VAR (x) +b VARY) EG: ConseER TWO GAMES : ComPuTe « ecx) = O em= 0. WiticH DO You PrereR ? compute «VARS A VAR CY) = 10 0V0 Game Y. was MORE VARIABILITY (SPREAD) CcouLd WIN /LOose more ) RECALL: {CONVEX FUNCTION (HOLDS WATERY — CONCAVE FUNCTION) (SPILLS WATERY fo € (ax+a-ar4) g ACERIACI-AILE) WA ECON) Cf es cz & ¥s0 => & Is CONVEX ) JENSEN INEQ.> LET KH BE A RV ON FINITE PROB. PACE Se . @e.e) . AND we) A CONVEX FUNCTION + THEN ° E(e(X)) % & (E00). . e “ APPUCATION -» @cxyex® => &(0 = 270 => CONVEX a a it & => CHD) % (EO) = EOS (EW) 2 O y y SS ev vt Ga raNe © deh EX) > YY Sreenn VARIX)=O =) e B VARIK) — ( X=consT.) i yo ers) = 7 VAR(S,) = ? ES) = Tl Sw P(e) = SCH POH) 4 Se CO POT) wwcturr3 a 2 VAR) = E reo] = e[e-s yl= = 2 Gilers Yrie) = WwesniTy = GC HY-5 POH # BITING Y POTD = @ sy 4 ter $, ae! STANDARD DEVIATION = c VARIANCE

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