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    Formulae

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    Mark Fesenco
    The document summarizes binomial tree and Black-Scholes models for valuing financial derivatives. It defines variables for the binomial tree model including arbitrage probability, stock and bond prices, and claim value. It also presents the Black-Scholes formula for valuing European call options using the stock price process and variables for interest rate, volatility and time. Finally, it provides Itô's lemma which describes how to calculate the stochastic process for a function of another stochastic process.

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    Formulae

    Uploaded by

    Mark Fesenco
    28 views1 page
    The document summarizes binomial tree and Black-Scholes models for valuing financial derivatives. It defines variables for the binomial tree model including arbitrage probability, stock and bond prices, and claim value. It also presents the Black-Scholes formula for valuing European call options using the stock price process and variables for interest rate, volatility and time. Finally, it provides Itô's lemma which describes how to calculate the stochastic process for a function of another stochastic process.

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    The document summarizes binomial tree and Black-Scholes models for valuing financial derivatives. It defines variables for the binomial tree model including arbitrage probability, stock and bond prices, and claim value. It also presents the Black-Scholes formula for valuing European call options using the stock price process and variables for interest rate, volatility and time. Finally, it provides Itô's lemma which describes how to calculate the stochastic process for a function of another stochastic process.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    28 views1 page

    Formulae

    Uploaded by

    Mark Fesenco
    The document summarizes binomial tree and Black-Scholes models for valuing financial derivatives. It defines variables for the binomial tree model including arbitrage probability, stock and bond prices, and claim value. It also presents the Black-Scholes formula for valuing European call options using the stock price process and variables for interest rate, volatility and time. Finally, it provides Itô's lemma which describes how to calculate the stochastic process for a function of another stochastic process.

    Copyright:

    © All Rights Reserved
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    of 1

    Binomial Tree - Summary

    erδt snow − sdown


    q = fup − fdown
    sup − sdown φ =
    −rδt
    sup − sdown
    fnow = e (qfup + (1 − q)fdown ) −1
    ψ = Bnow (fnow − φsnow )
    = f (1) = EQ BT−1 X
    
    V

    where

    q: arbitrage probability of up-jump r: interest rate in force over period


    f : claim value time-process s: stock price process
    φ: stock holding strategy B: bond price process, B0 = 1
    ψ: bond holding strategy Q: measure made up of the qs
    V : claim value at time zero X: claim payoff
    δt: length of period T : time of claim payoff

    Black-Scholes formula - (European call option)

    " + #
    √ σ2
    V = EQ S0 exp(σ T Z − T ) − k exp(−rT )
    2
    2
    ! !
    σ2
    log(S0 /k) + (r + σ2 )T log(S0 /k) + (r − )T
    = S0 Φ √ − ke−rT Φ √ 2
    σ T σ T

    Itô’s Lemma
    If X is a stochastic process, satisfying

    dXt = σt dWt + µt dt

    and f is a deterministic twice continuously differentiable function, then Yt = f (Xt ) is also a


    stochastic process and is given by
     
    0 0 1 2 00
    dYt = (σt f (Xt )) dWt + µt f (Xt ) + σt f (Xt ) dt.
    2

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