Assume the Black-Scholes framework. For j = 1, 2 and t 0, let S j (t)

Question:

Assume the Black-Scholes framework. For j = 1, 2 and t ≥ 0, let Sj(t) denote the time-t price of Stock j.

(a) Consider a T-year European contingent claim whose payoff is the maximum of the two stocks, max(S1(T), S2(T)). Show that the time-0 price of such a claim can be written as

Vmax = FT(S1) N In Fr(S1)/FT(S2)] + (02/2)T) (1), (8  +

where 

O Var[In(Fr(S1)/Fr(S2))]/t for t  (0,T].

Give the second term of the pricing formula. How does it compare with the first term? 

(b) Repeat part (a) for the T-year European contingent claim whose payoff is the minimum of the two stocks, min(S1(T), S2(T)).  

Fantastic news! We've Found the answer you've been seeking!

Step by Step Answer:

Related Book For  book-img-for-question
Question Posted: