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DISCRETE-TIME OPTION PRICING THEORY

Eric Emer

Defining Options

Relevant Parameters for pricing derivative:

Modeling Stock Price Behavior (1)


The lognormal distribution.

Modeling Stock Price Behavior (2)


Discrete-Time Geometric Brownian Motion

Modeling Stock Behavior (3)


Binomial Method

Binomial Model, Valuing European Call Option

Risk Neutrality

Binomial Method Calculation

One-Step Example

One-Step Example (2)

Example Problem using Binomial Method