EBK MATHEMATICS: A PRACTICAL ODYSSEY
8th Edition
ISBN: 8220100546112
Author: MOWRY
Publisher: Cengage Learning US
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Chapter A, Problem 24E
To determine
To calculate:
The value of
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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 A Solutions
EBK MATHEMATICS: A PRACTICAL ODYSSEY
Ch. A - Prob. 1ECh. A - Prob. 2ECh. A - Prob. 3ECh. A - Prob. 4ECh. A - Prob. 5ECh. A - Prob. 6ECh. A - Prob. 7ECh. A - Prob. 8ECh. A - Prob. 9ECh. A - Prob. 10E
Ch. A - Prob. 11ECh. A - Prob. 12ECh. A - Prob. 13ECh. A - Prob. 14ECh. A - Prob. 15ECh. A - Prob. 16ECh. A - Prob. 17ECh. A - Prob. 18ECh. A - Prob. 19ECh. A - Prob. 20ECh. A - Prob. 21ECh. A - Prob. 22ECh. A - Prob. 23ECh. A - Prob. 24ECh. A - Perform the calculations in Exercises 1-32. The...Ch. A - Perform the calculations in Exercises 1-32. The...Ch. A - Prob. 27ECh. A - Prob. 28ECh. A - Perform the calculations in Exercises 1-32. The...Ch. A - Prob. 30ECh. A - Prob. 31ECh. A - Perform the calculations in Exercises 1-32. The...Ch. A - Solve 4.2x2+8.3x+1.1=0 for x. Check your two...Ch. A - Solve 5.7x2+12.3x8.1=0 for x. Check your two...Ch. A - Prob. 35E
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