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If you're looking to price a European option under a stochastic short rate, you can take a look at the Bakshi, Cao and Chen (1997) paper. Some of their model combine stochastic volatility, jumps in the price process, as well as a stochastic short rate process -- such as what you ask. The convenience of their approach is that all of their models imply that ...


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Rebonato called the whole process "the wrong number in the wrong formula to get the right price". We use Black-Scholes much the same way that we look at price-earnings ratio in equities. This is beneficial for traders. First, it translates a fast-moving price into a slow moving valuation metric. Second, it gives us an idea of value. Is this option rich or ...


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1. Let me first reconcile the Black-Scholes pricing formula with the idea of prices being determined by supply-and-demand. Even if it is not explicitly said this way, from an equilibrium perspective, the Black-Scholes formula defines the unique price of risk that is consistent with the absence of arbitrage. In fact, you explicitly use this price when you ...


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