(a) Suppose that a finite market model consists of a bond B, and two risky assets...
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(a) Suppose that a finite market model consists of a bond B, and two risky assets St, Ssuch that Bo = S = S and that Br< + Construct an opportunity of arbitrage. (b) We consider a finite market model on 2 = {1, 2, 3} with T = 1, consisting of a bond B with interest rate r = 0 and Bo= 1 and two risky assets St, Swith Time Risky asset S t = 0 t = 1 16 S 11 S= 8 9 Risky asset SS=6 S 9 4 5 CT if w₁ occurs, if w₂ occurs, if w3 occurs, if w₁ occurs, if w₂ occurs, if w3 occurs. (i) Show that the model is arbitrage free and complete. (ii) Determine the arbitrage free price of a derivative with payoff ₁S+ min{S, 6} (iii) Determine a replicating strategy for the derivative with payoff ₁. (iv) Is the market model still arbitrage free if the interest rate r = 1? Justify your answer. (a) Suppose that a finite market model consists of a bond B, and two risky assets St, Ssuch that Bo = S = S and that Br< + Construct an opportunity of arbitrage. (b) We consider a finite market model on 2 = {1, 2, 3} with T = 1, consisting of a bond B with interest rate r = 0 and Bo= 1 and two risky assets St, Swith Time Risky asset S t = 0 t = 1 16 S 11 S= 8 9 Risky asset SS=6 S 9 4 5 CT if w₁ occurs, if w₂ occurs, if w3 occurs, if w₁ occurs, if w₂ occurs, if w3 occurs. (i) Show that the model is arbitrage free and complete. (ii) Determine the arbitrage free price of a derivative with payoff ₁S+ min{S, 6} (iii) Determine a replicating strategy for the derivative with payoff ₁. (iv) Is the market model still arbitrage free if the interest rate r = 1? Justify your answer.
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Answer rating: 100% (QA)
a To construct an arbitrage opportunity we need to find a portfolio of the bond and risky assets that has a guaranteed positive payoff at time T witho... View the full answer
Related Book For
Database management systems
ISBN: 978-0072465631
3rd edition
Authors: Raghu Ramakrishan, Johannes Gehrke, Scott Selikoff
Posted Date:
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