Exercise 14.4.13 The continuously compounded rate of return X ln S follows dX= (r 2/2) dt +

Exercise 14.4.13 The continuously compounded rate of return X≡ ln S follows dX= (r −σ2/2) dt +σ dW in a risk-neutral economy. Use this fact to show that u = exp[ (r −σ2/2) t +σ

√

t ], d = exp[ (r −σ2/2) t −σ

√

t ]

under the alternative binomial model in which an up move occurs with probability 1/2.