8 views

Uploaded by Josue Valladares Ruiz

bok

save

- FINAL Ceiling STUDY Taken for Corrections Web
- Ben Nani 1997
- Alfa Mobile NQI Project BSS RAN Parameters Recs Rev C
- Principles of Orebody Modeling_B.stanley
- creo3_behavioral.pdf
- Spss Copas
- Pp Master Data Configuration
- STSG
- ICap Manual - Oct 2012
- 1290-4992-1-PB
- Analyze of Baranyi Population Model .docx
- Yield Learning Modeling in Wafer Manufacturing
- Estimation Techniques for AS400
- A Comparative Study of Various Tests for Normality
- Understand Statistics
- PDF4LHC Practical Guide
- GeSCA Manual
- Rice formulae and Gaussian waves
- Maths
- Cost Aasensio
- Perova_Vakis_JuntosIE
- Gaussian KD tree filtering (reading group presentation)
- Bar Shalom, Daum Et Al 2009 - The Probabilistic Data Association Filter
- Fdocslide.us Problem Probability
- Normal Distributions Grading on the Bellcurve
- Intro to Probability - U of U
- Ronald Squibbs - Musical Composition as Applied Mathematics Set Theory and Probability in Iannis Xenakis Herma.pdf
- Applying Kalman Filtering in solving SSM estimation problem by the means of EM algorithm with considering a practical example
- 10.1007_s12205-013-0230-3
- Class 06 - Hypothesis Testing Cases
- PPT Semana Rinon 2016
- Case Hematemesis
- JUL-1 LICE
- Proiect de Lectie (1) Active Imobilizate
- Destilación Simple
- Kelas jalan & Kebutuhan bahan untuk PJU.docx
- 17_Hukum_Melde_sip.pdf
- El enfoque basado en competencias. Phillipe Perrenoud
- Introducción a Dropbox.pdf
- UAL BRIEF Unit 1 Logic User Guide Notes
- EPILEPSI.docx
- 2. TEORIA ELECTROMAGNETICA.doc
- 332080892-Jazz-Conception-by-Jim-Snidero-pdf.pdf
- Desain-Kurikulum
- WA 081.23.2626.994, Pembicara Seminar Creativepreneur,Cv Pembicara Seminar,Cari Pembicara Seminar
- API2
- Baby
- Biogas
- 01. SOP PEMANTAUAN EKG KONTINU (BA 2014).pdf
- Vacilatela.doc
- adcash
- Biologija VII final.doc
- LAPORAN PENDAHULUA11
- MONOGRAFIA Teoria de Sistemas
- LTM Agama Islam 2
- a
- story bord.docx
- journal 2
- Jalan Membuka Usaha Makeup Artist
- 31-51903 GE ZIP360NHA, ZIPP360NHASS, ZIPS360NHAS Momogram Refrigerator
- fix incom
- x D
- Commodity
- FX
- FX
- Fixed Income
- Ositran - Consideraciones Para El Examen CEU 2013
- Chapter 05
- CODIGOS VBA rSanchez
- ECO3210721-2014-1
- Diamond Bankruns 2007

You are on page 1of 5

3

The Black-Scholes Partial Differential Equation

**Let S be the price at time t of a particular asset. After a (short) time interval of length dt,
**

the asset price changes by dS, to S + dS. Rather than measuring the absolute change dS,

we measure the return on the asset which is defined to be

dS

.

S

Note: This return expresses the change in the asset price as a proportion of the original

asset price.

One common mathematical model of the return has two components. The first is a

predictable, deterministic component (similar to the return on a risk-free investment in a

bank). This is

µdt.

The parameter µ is called the drift. It is a measure of the average rate of growth of the asset

price.

The second contribution to the return dS

S is

σdX.

Here σ is called the volatility and is a measure of the standard deviation of the returns. The

quantity dX is a random variable having a normal distribution with mean 0 and variance

dt :

√

dX ∼ N (0, ( dt)2 ).

This component is a random contribution to the return. For each interval dt, dX is a sample

√

drawn from the distribution N (0, ( dt)2 ) - this is multiplied by σ to produce the term σdX.

The value of the parameters σ and µ may be estimated from historical data.

We obtain the following stochastic differential equation (stochastic analysis is the study

of functions of random variables).

dS

= µdt + σdX.

S

(4.1)

Notes

1. If σ = 0 then the behaviour of the asset price is totally deterministic and we have the

ordinary differential equation

dS

= µdt.

S

This can be solved to give

S = S0 eµt

where S0 is the asset price at time t = 0.

2. The equation 4.1 is an example of a random walk. It cannot be solved to give a

deterministic path for the share price but it gives probabilistic information about the

behaviour of S.

39

05)) = −0.4.35. assuming 250 business days in a year.2(−0. = 10 − 0.2(0. = 0.916.17.4/250 + 0.179. dS 10.2(0. dt = (This value of dt is basically one day. The equation 4.4/250 + 0.063.916(0.4/250 + 0. A value for dX is chosen from N (0. Step 1 S0 = 10. Step 2 S1 = 9. = 9.179 = 10.4/250 + 0. 250 µ = 0.17.17(0.1 can be considered to be a scheme for constructing time series that may be realised by share prices.4/250 + 0.3. take dX = 0. 1/250) .12) = 9.08) = 10. σ = 0. dS 9.916.4/250 + 0.08.05) = 10(0.17 dS S1 The following is a graphical representation of this time series : 40 .08)) = 0. = 10. Then dS 10 dS S1 = 0.1 The price S of a particular share today is e10.254 = 10.choose dX = −0.916 + 0.17 + 0. Here dX is drawn (at each step) from a normal distribution with mean 0 and standard √ deviation 1/ 250 ≈ 0.916 dS S2 Step 3 S2 = 10.2(0.) Solution: We have dS − µdt + σdX = 0.4 S 1 250 + 0. Example 4.2(−0.12)) = 0.2dX.254. = 0.2.084.2(0.05. take dX = 0.084 = 9.12.3. Construct a time series for the share price over three intervals if 1 .

...... .. If this time step were used in practice however......... . 10..2 s 10.. ...............S 10.... We need Itˆ o’s Lemma....... .... .... .. .... . ... ........ .... . .. .... .. We finish these lecture notes now with a brief outline of such a model...... ...4 s s . ........ . ........ . ... . ... .. .. ... . .... ......... .8 s s t=0 s s s t = 1/250 s t=2/250 s t = 3/250 In real life asset prices are quoted at discrete intervals of time... .... . ............. .. . The Taylor Series of f at x = a is ∞ X f (n) (a) (x − a)n . .. .......... .. .. Recall: Taylor Series Let f be a function with derivatives of all orders on an interval I containing a point a.... ....... .. which is a version of Taylor’s Theorem for functions of random variables.. .. ...... ... . ..... ... n! n=0 If this series converges to f on I then f (x) = f (a) + =⇒ f (x) − f (a) = ∞ X f (n) (a) (x − a)n n! n=1 ∞ X f (n) (a) (x − a)n ........... .. . .... and so there is a practical lower bound for the basic time step dt of our random walk... n! n=1 Now replace x with x + ∆x and a with x to obtain f 00 (x) (∆x)2 + ... . ..... ..0 s 9. .. .. ... ... .... ........... ... .... ...... One approach is to develop a continuous model by taking a limit as dt −→ 0...... We now return to our consideration of what happens to ∆f = f (x + ∆x) − f (x) = f 0 (x) + dS = µdt + σdX S 41 .. ... .. . 2! This relates the small change ∆f in the function f to the small change ∆x in x. .. ...... the sheer quantity of data involved would be unmanageable...

. The value of the portfolio is Π = V − ∆S. There is a deterministic component dt and a random component dX. We need the following fact which we state without proof : With probability 1 (dX)2 −→ dt as dt −→ 0. dS 2 dS 2 Now dS = S(µdt + σdS) and (dS)2 = S 2 µ2 (dt)2 + 2µσdtdX + σ 2 (dX)2 Now since (dX)2 −→ dt as dt −→ 0. dV = σS ∂S ∂S 2 ∂S ∂t Consider a portfolio containing one option and −∆ units of the underlying stock. t) be the value of an option (this is usually called C(S. In fact we need a version of Itˆ o’s Lemma for a function of more than one variable : if f is a function of two variables S. dX + µS + σ2S 2 2 + df = σS ∂S ∂S 2 ∂S ∂t The Black-Scholes PDE Let V (S. the term S 2 σ 2 (dX)2 dominates the above expression for (dS)2 as dt becomes small. . If we change S by a small amount dS then by Taylor’s Theorem we have df = 1 d2 S df dS + (dS)2 + . dS dS 2 dt This is Itˆ o’s Lemma relating a small change in a function of a random variable to a small change in the variable itself. Retaining only this term we use S 2 σ 2 dt as an approximation for (dS)2 as dt −→ 0. t) for a call and P (S. t) for a put). Let r be the interest rate and let µ and σ be as above.as t −→ 0. We then have df df = df 1 d2 S 2 2 (S σ dt) dS + dS 2 dt2 = df d2 S (Sµdt + σdX) + 2 (S 2 σ 2 dt) dS dt = σS df 1 d2 S df dX + µS + σ 2 S 2 2 dt. Using Itˆ o’s Lemma we have ∂V 1 ∂2V ∂V ∂V dX + µS + σ2S 2 2 + dt. t we have ∂f ∂f 1 ∂2f ∂f dt. Suppose that f (S) is a function of the asset price S. 42 .

∂V 1 ∂2V ∂V + σ 2 S 2 2 + rS − rV = 0. Then for a fair price we should have 1 2 2 ∂2V ∂V rΠdt = dt σ S + 2 ∂S 2 ∂t ∂V S = =⇒ r V − ∂S ∂V 1 2 2 ∂2V + σ S 2 ∂S 2 ∂t Thus we obtain the Black-Scholes PDE. Now if Π was invested in riskless assets it would see a growth of rΠdt in the interval of length dt. dΠ = σS = σS Choose ∆ = ∂V ∂V 1 ∂2V ∂V dt − ∆Sµdt − ∆SσdX dX + µS + σ2S 2 2 + ∂S ∂S 2 ∂S ∂t ∂V ∂V 1 ∂2V ∂V − ∆ dX + µS + σ2S 2 2 + − µ∆S dt ∂S ∂S 2 ∂S ∂t ∂V to get ∂S dΠ = ∂V 1 2 2 ∂2V + σ S 2 2 ∂S ∂t dt. ∂t 2 ∂S ∂S 43 .Thus dΠ = dV − ∆dS.

- FINAL Ceiling STUDY Taken for Corrections WebUploaded byVardhaman Pandey
- Ben Nani 1997Uploaded bysabans sidharthan
- Alfa Mobile NQI Project BSS RAN Parameters Recs Rev CUploaded byAbraham Moctar Wonkoye
- Principles of Orebody Modeling_B.stanleyUploaded byMichael Brian
- creo3_behavioral.pdfUploaded bygggg
- Spss CopasUploaded byDesak Januari
- Pp Master Data ConfigurationUploaded byfomenvad
- STSGUploaded byJitendraBhaskar
- ICap Manual - Oct 2012Uploaded byecocadec
- 1290-4992-1-PBUploaded byJigar M. Upadhyay
- Analyze of Baranyi Population Model .docxUploaded byEthan Chen
- Yield Learning Modeling in Wafer ManufacturingUploaded bysamuelsouzaserafim
- Estimation Techniques for AS400Uploaded byskumargupta
- A Comparative Study of Various Tests for NormalityUploaded byElizabeth Collins
- Understand StatisticsUploaded bysor_68m
- PDF4LHC Practical GuideUploaded byJeffrey Peeko
- GeSCA ManualUploaded byMuslim Ukm
- Rice formulae and Gaussian wavesUploaded byadaniliu14
- MathsUploaded byShivam Maurya
- Cost AasensioUploaded byjenghiskhan
- Perova_Vakis_JuntosIEUploaded byJUSTIN
- Gaussian KD tree filtering (reading group presentation)Uploaded bytwak
- Bar Shalom, Daum Et Al 2009 - The Probabilistic Data Association FilterUploaded byRudiali
- Fdocslide.us Problem ProbabilityUploaded byawesome112358
- Normal Distributions Grading on the BellcurveUploaded bykokolay
- Intro to Probability - U of UUploaded byChris Whiting
- Ronald Squibbs - Musical Composition as Applied Mathematics Set Theory and Probability in Iannis Xenakis Herma.pdfUploaded byhaex
- Applying Kalman Filtering in solving SSM estimation problem by the means of EM algorithm with considering a practical exampleUploaded byJournal of Computing
- 10.1007_s12205-013-0230-3Uploaded byIshit Dhada
- Class 06 - Hypothesis Testing CasesUploaded byb_shadid8399

- fix incomUploaded byJosue Valladares Ruiz
- x DUploaded byJosue Valladares Ruiz
- CommodityUploaded byJosue Valladares Ruiz
- FXUploaded byJosue Valladares Ruiz
- FXUploaded byJosue Valladares Ruiz
- Fixed IncomeUploaded byJosue Valladares Ruiz
- Ositran - Consideraciones Para El Examen CEU 2013Uploaded byJosue Valladares Ruiz
- Chapter 05Uploaded byJosue Valladares Ruiz
- CODIGOS VBA rSanchezUploaded byJosue Valladares Ruiz
- ECO3210721-2014-1Uploaded byJosue Valladares Ruiz
- Diamond Bankruns 2007Uploaded byJosue Valladares Ruiz