Answered step by step

Verified Expert Solution

## Question

1 Approved Answer

# 15. [5] It's not so difficult to incorporate time-varying volatility into the BSM model as long as the time variation is not random. Assume

## 15. [5] It's not so difficult to incorporate time-varying volatility into the BSM model as long as the time variation is not random. Assume a BSM economy, but this time, assume that the volatility of the stock varies over time deterministically: is not a constant but a (bounded) function of time. Derive the price of a European call. For simplicity, assume that today is time 0; that is, the remaining time to maturity is simply T and not T - t. Hints: The price of a European call when the volatility is constant is -rT So(d1) Ke (d2) where d = log()+(r+o)T and d = log()+(r-o)T Use the risk-neutral valuation approach, not the PDE approach.

## Step by Step Solution

There are 3 Steps involved in it

### Step: 1

### Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

### Step: 2

### Step: 3

## Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started