Essentials of Discrete Mathematics
3rd Edition
ISBN: 9781284056242
Author: David J. Hunter
Publisher: Jones & Bartlett Learning
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Chapter 1.5, Problem 3E
To determine
The proof for the given statement.
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Construct a know-show table for each statement below that appears to be true.
Problem 3. Pricing a multi-stock option the Margrabe formula
The purpose of this problem is to price a swap option in a 2-stock model, similarly as
what we did in the example in the lectures. We consider a two-dimensional Brownian
motion given by W₁ = (W(¹), W(2)) on a probability space (Q, F,P). Two stock prices
are modeled by the following equations:
dX
=
dY₁ =
X₁ (rdt+
rdt+0₁dW!)
(²)),
Y₁ (rdt+dW+0zdW!"),
with Xo
xo and Yo =yo. This corresponds to the multi-stock model studied in class,
but with notation (X+, Y₁) instead of (S(1), S(2)). Given the model above, the measure
P is already the risk-neutral measure (Both stocks have rate of return r). We write
σ = 0₁+0%. We consider a swap option, which gives you the right, at time T, to
exchange one share of X for one share of Y. That is, the option has payoff
F=(Yr-XT).
(a) We first assume that r = 0 (for questions (a)-(f)). Write an explicit expression for
the process Xt.
Reminder before proceeding to question (b): Girsanov's theorem…
Problem 1. Multi-stock model
We consider a 2-stock model similar to the one studied in class. Namely, we consider
=
S(1)
S(2)
=
S(¹) exp (σ1B(1) + (M1 - 0/1 )
S(²) exp (02B(2) + (H₂-
M2
where (B(¹) ) +20 and (B(2) ) +≥o are two Brownian motions, with
t≥0
Cov (B(¹), B(2)) = p min{t, s}.
"
The purpose of this problem is to prove that there indeed exists a 2-dimensional Brownian
motion (W+)+20 (W(1), W(2))+20 such that
=
S(1)
S(2)
=
=
S(¹) exp (011W(¹) + (μ₁ - 01/1) t)
롱)
S(²) exp (021W (1) + 022W(2) + (112 - 03/01/12) t).
where σ11, 21, 22 are constants to be determined (as functions of σ1, σ2, p).
Hint: The constants will follow the formulas developed in the lectures.
(a) To show existence of (Ŵ+), first write the expression for both W. (¹) and W (2)
functions of (B(1), B(²)).
as
(b) Using the formulas obtained in (a), show that the process (WA) is actually a 2-
dimensional standard Brownian motion (i.e. show that each component is normal,
with mean 0, variance t, and that their…
Chapter 1 Solutions
Essentials of Discrete Mathematics
Ch. 1.1 - Prob. 1ECh. 1.1 - Prob. 2ECh. 1.1 - Prob. 3ECh. 1.1 - Prob. 4ECh. 1.1 - Prob. 5ECh. 1.1 - Prob. 6ECh. 1.1 - Prob. 7ECh. 1.1 - Prob. 8ECh. 1.1 - Prob. 9ECh. 1.1 - Prob. 10E
Ch. 1.1 - Prob. 11ECh. 1.1 - Prob. 12ECh. 1.1 - Prob. 13ECh. 1.1 - Prob. 14ECh. 1.1 - Prob. 15ECh. 1.1 - Prob. 16ECh. 1.1 - Prob. 17ECh. 1.1 - Prob. 18ECh. 1.1 - Prob. 19ECh. 1.1 - Prob. 20ECh. 1.1 - Prob. 21ECh. 1.1 - Prob. 22ECh. 1.1 - Prob. 23ECh. 1.1 - Prob. 24ECh. 1.1 - Prob. 25ECh. 1.1 - Prob. 26ECh. 1.1 - Prob. 27ECh. 1.1 - Prob. 28ECh. 1.1 - Prob. 29ECh. 1.1 - Prob. 30ECh. 1.1 - Prob. 31ECh. 1.1 - Prob. 32ECh. 1.2 - Prob. 1ECh. 1.2 - Prob. 2ECh. 1.2 - Prob. 3ECh. 1.2 - Prob. 4ECh. 1.2 - Prob. 5ECh. 1.2 - Prob. 6ECh. 1.2 - Prob. 7ECh. 1.2 - Prob. 8ECh. 1.2 - Prob. 9ECh. 1.2 - Prob. 10ECh. 1.2 - Prob. 11ECh. 1.2 - Prob. 12ECh. 1.2 - Prob. 13ECh. 1.2 - Prob. 14ECh. 1.2 - Prob. 15ECh. 1.2 - Prob. 16ECh. 1.2 - Prob. 17ECh. 1.2 - Prob. 18ECh. 1.2 - Prob. 19ECh. 1.2 - Prob. 20ECh. 1.2 - Prob. 21ECh. 1.2 - Prob. 22ECh. 1.2 - Prob. 23ECh. 1.2 - Prob. 24ECh. 1.2 - Prob. 25ECh. 1.2 - Prob. 26ECh. 1.2 - Prob. 27ECh. 1.2 - Prob. 28ECh. 1.3 - Prob. 1ECh. 1.3 - Prob. 2ECh. 1.3 - Prob. 3ECh. 1.3 - Prob. 4ECh. 1.3 - Prob. 5ECh. 1.3 - Prob. 6ECh. 1.3 - Prob. 7ECh. 1.3 - Prob. 8ECh. 1.3 - Prob. 9ECh. 1.3 - Prob. 10ECh. 1.3 - Prob. 11ECh. 1.3 - Prob. 12ECh. 1.3 - Prob. 13ECh. 1.3 - Prob. 14ECh. 1.3 - Prob. 15ECh. 1.3 - Prob. 16ECh. 1.3 - Prob. 17ECh. 1.3 - Prob. 18ECh. 1.3 - Prob. 19ECh. 1.3 - Prob. 20ECh. 1.3 - Prob. 21ECh. 1.3 - Prob. 22ECh. 1.3 - Prob. 23ECh. 1.3 - Prob. 24ECh. 1.3 - Prob. 25ECh. 1.4 - Prob. 1ECh. 1.4 - Prob. 2ECh. 1.4 - Prob. 3ECh. 1.4 - Prob. 4ECh. 1.4 - Prob. 5ECh. 1.4 - Prob. 6ECh. 1.4 - Prob. 7ECh. 1.4 - Prob. 8ECh. 1.4 - Prob. 9ECh. 1.4 - Prob. 10ECh. 1.4 - Prob. 11ECh. 1.4 - Prob. 12ECh. 1.4 - Prob. 13ECh. 1.4 - Prob. 14ECh. 1.4 - Prob. 15ECh. 1.4 - Prob. 16ECh. 1.4 - Prob. 17ECh. 1.4 - Prob. 18ECh. 1.4 - Prob. 19ECh. 1.4 - Prob. 20ECh. 1.4 - Prob. 21ECh. 1.4 - Prob. 22ECh. 1.4 - Prob. 23ECh. 1.4 - Prob. 24ECh. 1.4 - Prob. 25ECh. 1.4 - Prob. 26ECh. 1.4 - Prob. 27ECh. 1.4 - Prob. 28ECh. 1.4 - Prob. 29ECh. 1.4 - Prob. 30ECh. 1.5 - Prob. 1ECh. 1.5 - Prob. 2ECh. 1.5 - Prob. 3ECh. 1.5 - Prob. 4ECh. 1.5 - Prob. 5ECh. 1.5 - Prob. 6ECh. 1.5 - Prob. 7ECh. 1.5 - Prob. 8ECh. 1.5 - Prob. 9ECh. 1.5 - Prob. 10ECh. 1.5 - Prob. 11ECh. 1.5 - Prob. 12ECh. 1.5 - Prob. 13ECh. 1.5 - Prob. 14ECh. 1.5 - Prob. 15ECh. 1.5 - Prob. 16ECh. 1.5 - Prob. 17ECh. 1.5 - Prob. 18ECh. 1.5 - Prob. 19ECh. 1.5 - Prob. 20ECh. 1.5 - Prob. 21ECh. 1.5 - Prob. 22ECh. 1.5 - Prob. 23ECh. 1.5 - Prob. 24ECh. 1.5 - Prob. 25E
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