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Risk-neutral probabilitiesƒ 209

Properties of p’ and q’

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p’ and q’ are positive: due to the no-arbitrage assumption, 0 < d < 1+r < u.

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p’ and q’ sum to one: p’ + q’ = p’ + 1 - p’ = 1.

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0 < p’ < 1:

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We can regard p’ and q’ as probablities of head and tail, respectively.

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Derivative securities: Options - Binomial asset pricing model