Question: 5. Consider a complete one-period model with N = {W, W2, W3, W} and let V, V, V, and V4 denote the Arrow-Debru securities

5. Consider a complete one-period model with N = {W, W2, W3, W} and let V, V, V, and V4 denote the Arrow-Debru securities with payment functions vi (w) = { Assume that the initial prices of these securities are W(w) = 14, W (W) 1 V = $0.38, V = $0.095, V = $0.19, V = $0.285. 0 (a) Find the arbitrage-free price W of the derivative security W with payment function W given by = W = Wi w=wi. Vi (w) = (b) Determine the interest rate r. 6. Consider a one-period model with {W, W, ..., WN}. Let V, V,..., VN denote the Arrow-Debru securities which make payments P(wi) = = = 3, W(W3) = 0, W(w) = -6. W = Wi w #Wi Assume that the prices V, V2,...,VN of the Arrow-Debru securities at time t : known. = (a) Let Vi V + V + + VN 0 are gives a risk-neutral probability measure P. (b) Is this the only risk-neutral probability measure in this model, or could there be others?

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a To find the arbitragefree price W of the derivative security W we can use the riskneutral pricing formula The price of W at time t0 is given by W W ... View full answer

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