Consider an option with value V(S, t), which has payoff at time T. Reduce the Black Scholes
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Consider an option with value V(S, t), which has payoff at time T. Reduce the Black– Scholes equation, with final and boundary conditions, to the diffusion equation, using the following transformations:
(a)
(b)
v = eαx+βτu(x, τ ),
for some α and β. What is the transformed payoff? What are the new initial and boundary conditions? Illustrate with a vanilla European call option.
Transcribed Image Text:
S= Ee", t= T - o2' V(S, t) = Ev(x, t), |
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a The transformed payoff is V E e t e x u x b The new initial cond...View the full answer
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