Microsoft PowerPoint - PoF.ppt

The replicating portfolioƒ 204

From the wealth equations (i) and (ii) we get:

ƒ

Recall:

The initial wealth, X

0

, needed to set up the

replicating portfolio is the no-arbitrage price of the derivative at time zero. Thus,B

0

= X

0

• 
  

'

0

S

0

Ä

X

0

=

'

0

S

0

+ B

0

= V

0

, by no-arbitrage!

Derivative securities: Options - Binomial asset pricing model

(

)

(

)

()

(

)

(

)

()()

.

1

&

1

1

0

1 0

1

0

r

d

u

H

dV

T

uV

B

S

d

u

T

V

H

V

• 
  

−

−

=

−

−

=

∆