Hot answers tagged option-pricing
Behavioral Finance is a wide topic, which I believe is still today underestimated by many financial professionals. How can it be used by quants? Well, in portfolio optimization it can be used "as an overlay" in the form of constraints where the optimal portfolio can not be too different from the current portfolio, because clients have behavioral biases ...
In effect, you are wondering whether to price this option on risk-free probability distributions (B-S drift $r_f$), or real-world ones (B-S drift $\mu$, however calibrated) One cannot short the mutual fund, so the argument for using risk-free is weakened. But, there are various economic equilibrium arguments why using it may still be OK. If you use the ...
Look the first answer of this thread: How to derive the implied probability distribution from B-S volatilities? Also many papers in Dupire volatility have your formula derivation. For example, look at (10) in http://www.javaquant.net/papers/DupireLocalVolatility.pdf
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