Suppose you are given the following data: ¢ Risk-free yearly interest rate is r = 6%. ¢
Question:
¢ Risk-free yearly interest rate is r = 6%.
¢ The stock price follows:
St St1 = μSt + ÏStεt
where the εt is a serially uncorrelated binomial process assuming the following values:
The 0 ¢ Volatility is 12% a year.
¢ The stock pays no dividends and the current stock price is 100.
Now consider the following questions.
(a) Suppose μ is equal to the risk-free interest rate:
μ = r
and that the St is arbitrage-free. What is the value of p?
(b) Would a p = 1/3 be consistent with arbitrage-free St?
Now suppose μ is given by:
μ = r + risk premium
(c) What do the p and εt represent under these conditions?
(d) Is it possible to determine the value of p?
Fantastic news! We've Found the answer you've been seeking!
Step by Step Answer:
Related Book For
An Introduction to the Mathematics of Financial Derivatives
ISBN: 978-0123846822
3rd edition
Authors: Ali Hirsa, Salih N. Neftci
Question Posted: