Consider a stock St and a plain vanilla, at-the-money, put option written on this stock. The option
Question:
(a) Using the arbitrage theorem, write down a three-equation system with two states that gives the arbitrage-free values of Sr and Ct.
(b) Now plot a two-step binomial tree for St. suppose at every node of the tree the markets are arbitrage-free. How many three-equation systems similar to the preceding case could then be written for entire tree?
(c) Can you find a three-equation system with 4 states that corresponds to the same tree?
(d) How do we know that all the implied state prices are internally consistent?
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Related Book For
An Introduction to the Mathematics of financial Derivatives
ISBN: 978-0123846822
2nd Edition
Authors: Salih N. Neftci
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