2. Consider a three-period binomial model in Figure 2 with So 4, u = 2, and...

 

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2. Consider a three-period binomial model in Figure 2 with So 4, u = 2, and d = risk-free rate is 10% at each period. The payoff of the focus asset is S3. = = 1/2. The (a) What is the no-arbitrage price of V₁(H)? (b) How many shares of stock should one hold in the replicated portfolio X₁(H)? (c) What is the risk-neutral distribution of S3 (S₁ = S₁ (H)), i.e., the condition distribution S₁ (H) under the risk-neutral measure? of S3 given S₁ (d) Based on the conditional distribution that you obtained in 2(c), compute Ê [V3|(S₁ = S₁(H))]. What can you find by comparing your result with that in 2(a)? So S₁ (H) = uso S1 (T)=dSo S2(HH)=u²So S2(HT) = S₂(TH) = udSo S2(TT)= d'So S3(HHH)=u³So S3(HHT) = S3(HTH) = S3(THH)=u²dSo S3(HTT) = S(THT) = S3(TTH) = ud² So S3(TTT)=d³ So Figure 2: Three-period binomial model. 2. Consider a three-period binomial model in Figure 2 with So 4, u = 2, and d = risk-free rate is 10% at each period. The payoff of the focus asset is S3. = = 1/2. The (a) What is the no-arbitrage price of V₁(H)? (b) How many shares of stock should one hold in the replicated portfolio X₁(H)? (c) What is the risk-neutral distribution of S3 (S₁ = S₁ (H)), i.e., the condition distribution S₁ (H) under the risk-neutral measure? of S3 given S₁ (d) Based on the conditional distribution that you obtained in 2(c), compute Ê [V3|(S₁ = S₁(H))]. What can you find by comparing your result with that in 2(a)? So S₁ (H) = uso S1 (T)=dSo S2(HH)=u²So S2(HT) = S₂(TH) = udSo S2(TT)= d'So S3(HHH)=u³So S3(HHT) = S3(HTH) = S3(THH)=u²dSo S3(HTT) = S(THT) = S3(TTH) = ud² So S3(TTT)=d³ So Figure 2: Three-period binomial model. 2. Consider a three-period binomial model in Figure 2 with So 4, u = 2, and d = risk-free rate is 10% at each period. The payoff of the focus asset is S3. = = 1/2. The (a) What is the no-arbitrage price of V₁(H)? (b) How many shares of stock should one hold in the replicated portfolio X₁(H)? (c) What is the risk-neutral distribution of S3 (S₁ = S₁ (H)), i.e., the condition distribution S₁ (H) under the risk-neutral measure? of S3 given S₁ (d) Based on the conditional distribution that you obtained in 2(c), compute Ê [V3|(S₁ = S₁(H))]. What can you find by comparing your result with that in 2(a)? So S₁ (H) = uso S1 (T)=dSo S2(HH)=u²So S2(HT) = S₂(TH) = udSo S2(TT)= d'So S3(HHH)=u³So S3(HHT) = S3(HTH) = S3(THH)=u²dSo S3(HTT) = S(THT) = S3(TTH) = ud² So S3(TTT)=d³ So Figure 2: Three-period binomial model. 2. Consider a three-period binomial model in Figure 2 with So 4, u = 2, and d = risk-free rate is 10% at each period. The payoff of the focus asset is S3. = = 1/2. The (a) What is the no-arbitrage price of V₁(H)? (b) How many shares of stock should one hold in the replicated portfolio X₁(H)? (c) What is the risk-neutral distribution of S3 (S₁ = S₁ (H)), i.e., the condition distribution S₁ (H) under the risk-neutral measure? of S3 given S₁ (d) Based on the conditional distribution that you obtained in 2(c), compute Ê [V3|(S₁ = S₁(H))]. What can you find by comparing your result with that in 2(a)? So S₁ (H) = uso S1 (T)=dSo S2(HH)=u²So S2(HT) = S₂(TH) = udSo S2(TT)= d'So S3(HHH)=u³So S3(HHT) = S3(HTH) = S3(THH)=u²dSo S3(HTT) = S(THT) = S3(TTH) = ud² So S3(TTT)=d³ So Figure 2: Three-period binomial model.

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SOLUTION To answer these questions we need to use the principles of the binomial option pricing model Lets go through each question step by step a The ... View the full answer