I have been trying to resolve this problem, under (b), but I cannot find the correct answer. For i=1, my ultimate answer (P=1) deviates from the correct answer (P=0.7580). Please let me know whether my computations are wrong or not.

In blue is the solution according to the solution manual; my computations start at For i=1.

BS vs real world prolbem

  • $\begingroup$ Start by re-arranging the algebraic variables and "solve" for the normal RV, instead of plugging in the numerical values first. Because it seems as though you've missed moving ln(S_0) to the RHS $\endgroup$ – Tingiskhan Mar 21 '17 at 17:19

I wrongly assumed that that a random normal variable's distribution was described by its mean and volatility. It is, however, described by its mean and variance.

So for the denominator in the Z computation I now use 0.1 (volatility) instead of 0.01 (the variance, which I had mistaken to be volatility), which results in the right answer.

| improve this answer | |
  • $\begingroup$ Characterising a random variable through (mean, standard deviation) or (mean, variance) is actually exactly the same. But indeed to compute the Z-score you should center the variable then divide the output by that variable's standard deviation not its variance. $\endgroup$ – Quantuple Mar 22 '17 at 8:42
  • $\begingroup$ you may accept your own answer so that it will not show up again. $\endgroup$ – Gordon Apr 20 '17 at 18:47

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.