Microsoft PowerPoint - PoF.ppt

One-period binomial modelƒ 198

Time 0: S

0

... price per share, a positive quantity known at

time zero.

ƒ

Time 1: The price per share will be one of two positive values: S

(H) or S 1

(T). 1

ƒ

Assume:

ƒ

Probability of head (stock price increase), p, is positive.

ƒ

Probability of tail (stock price decrease), q = (1-p), is also positive.

ƒ

The outcome of the coin toss, and hence S

(H) or S 1

(T), is 1

known at time one but not at time zero, it is random.

ƒ

u = S

(H) / S 1

0

> 0 and d = S

(T) / S 1

0

> 0

Derivative securities: Options - Binomial asset pricing model