Q2. Consider the 2-period Cox-Ross-Rubinstein (CRR) binomial model with So = K = 1,T= 1, At...

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Q2. Consider the 2-period Cox-Ross-Rubinstein (CRR) binomial model with So = K = 1,T= 1, At = 0.5, = 0.2, u = 1/d = exp(oAt), and continuously compounded interest rate r = 0.05. (a) State the martingale property of discounted underlying asset prices, and derive the CRR risk-neutral probabilities p, and q = 1 - p. (a) For both call and put options, calculate the price Vo and the initial replicating portfolio ((B), (5)). (b) Compare the signs of the delta hedging value (5) for call and put options. Comment. (c) Now with = 0.4, re-calculate the price and delta hedging strategy of a call option. (d) Graph the discounted profit of the call options, defined as exp(-rT)VT - Vo, for = {0.2,0.4}. Compare and comment on pricing and hedging differences. Q2. Consider the 2-period Cox-Ross-Rubinstein (CRR) binomial model with So = K = 1,T= 1, At = 0.5, = 0.2, u = 1/d = exp(oAt), and continuously compounded interest rate r = 0.05. (a) State the martingale property of discounted underlying asset prices, and derive the CRR risk-neutral probabilities p, and q = 1 - p. (a) For both call and put options, calculate the price Vo and the initial replicating portfolio ((B), (5)). (b) Compare the signs of the delta hedging value (5) for call and put options. Comment. (c) Now with = 0.4, re-calculate the price and delta hedging strategy of a call option. (d) Graph the discounted profit of the call options, defined as exp(-rT)VT - Vo, for = {0.2,0.4}. Compare and comment on pricing and hedging differences.

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a The martingale property of discounted underlying asset prices states that under the riskneutral probability measure the expected discounted price of ... View the full answer