SIMPLE MODEL

2
My I

lytta
Y k e
h I
i
I 2
W
3

Sitting o_ltistogrormatt
t

EoiLW.I
74 0

VARELWI Kitko et
L

Histogram at 8 2

I Ewe
Yg C 2
the 2 µ f pyas
1 0 0

VAROEW.is
14 L 25
1 02 44.22
11 0 1 2 t 3
Histogram at
Mr
EgEWD 4qC 31

f
Yoo C 17 481 11 0

O q My
VARGEws Yg 9 361 36.1 48.9 18 85 3

I My expectation of future wealth is my current

wealth MARTINGALE
is increasing
variance of future wealth
2 My
linearly in time

Sitt I
Histogram at t 2

EEwelws 13
ffs ffs
12.0 1 2

VARE Wel we 13
42.02 1 2 I 12 2 1 2
c 3
Histogram at

EILWslhh.tt
My L 1 42 I µ d
TY L
TIM
j
3 Yg 13g Ey
L

VAriWs1We l

Kyd 42.12 4.3 I

44 112 9 44 2
4
 3 Changes in wealth elemys have the
same histogram distribution
9
MEMORY YESS

Std B M Wt N N Lo t

8 Wt n N Coff o t

owe NC µ.tt 0 o2 t
Gen Bar It pot

no

time

Time t t that
extremely small amount of time

d We Wtae Wt debts te dt to dwt

d It
 I
B S model

St µ dt od wt CA
dtg
BM
gem
instantaneous returns

IstockpricefollowsoGROMRTacBi

Sitting at t 0
Timento Maturity
CT El to CW Wt
Stock S I St exp µ 1207
N LO T t
Il t o

S So exp Ca 1202 T owe

ko

so
fWW
etiieer.ie
BOND By Bt exp
R T t
S iisd.is rrbutedoslog normel

B S Formula
real prob

E.cc
expCrOc.t
risk adjusted
1
where G CST K
risk neutral
OR
C Eo L
exp t
risk free

piece I expert c

Under real prob plan

St Slo exp pi toe TtoWe
Under risk neutral Q µwT
Sr Sp expler tzo4Tto w
 real prob S
Is risk neutral s

Hmwk IEEE To

Hint formula her taking exp of

p Eo9CCS exp C
rt

Roi CSIKI.tt kD.expL rD

Payoff
T
a

Si

Se Lse KB
Co IEEE experts
 IEFEKHLCSezkdexec
r FIEE.ge req
ICs KD
a
EFC St expert
eqsEEinjeE
k expert IP Sisk
l
risk strike PV probability
napery price
p
RNP of exercising

io.ua
EEXEEP

Kde dade
standard normal
Probability
is less da
 Cde Elda
risk neutral prob
of exercising
rT
HMWk Sy E epC

9 cat ds
Sp
et HMWk

Use Put Cole Dority

to derive the B S formulae

for a Put option