# Tag Info

5

Joshi is correct. The no arbitrage argument implies that the stock price instantaneous return under the risk neutral measure is equal to the short rate, and the girsanov theorem implies that the instantaneous volatility $\sigma$ is the same under the historical measure and under the risk neutral measure, so under the risk neutral measure the stock price is a ...

4

To compute the price of an American option or a callable instrument in general, at each potential exercise date, one is required to compare its continuation value (discounted risk-neutral expectation of what the option would pay off if it was not exercised) to the relevant exercise value/early redemption price. By construction, lattice and finite difference ...

2

Find the conditions under which: $E_{0}^{*}[\max (P_{T} - HR\times G_T, 0)] = \max (P_{0} - HR\times G_0, 0)$ We have a no-brainer solution - the condition that the drift and volatility of both $P$ and $G$ is zero, which means $P$ and $G$ are constants in time. Second valid condition - the option is deep in the money or deep out of the money, such that ...

2

In a practical manner, here is how you get to the PDE of your option: Use Girsanov theorem to go from the real-world measure to the risk-neutral measure (basically subtract the market price of risk $\mathrm dW^Q_t = \mathrm d W^P_t - \frac{\mu -r}{\sigma} \mathrm dt$). Discounted option price $e ^{-rt} v(t, S_t)$ has to be a martingale in the risk-neutral ...

2

Let $c_t$ be the price of an European call with maturity $T$ and $D_{t,T}$ the discount factor from $T$ to $t$. We assume deterministic rates. Then note that for $s<t\leq T$: \begin{align} E^Q_s\left(c_t\right)&=E^Q_s\left(E^Q_t\left(D_{t,T}(S_T-K)^+\right)\right) \\[3pt] &=E^Q_s\left(D_{t,T}(S_T-K)^+\right) \\[3pt] &=E^Q_s\left(\frac{D_{s,t}...

1

Exactly what @Alex C said. It's the time homogeneous diffusion proprety. You can't state such an argument in models where volatility is no longer time homogeneous ( that's being time independant and depending only on the underlyings).

1

I assume we are talking about swaptions here? Then your formula looks correct, under a couple of assumptions; first, from the context of the question, you are assuming that you delta hedge once a day at the close of business. Second, you have implicitly assumed that the gamma is constant over the region of the daily move, which is ok as long as the option ...

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