Exercise 9 6 7 (1) Someone argues that we should use (er t d) (ud) as the risk neutral probability thus Because the option value is independent of the stocks expected return q, it can be replaced with r Show him the mistakes (2) Suppose that we are asked to use the original risk neutral probability...

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Exercise 9.6.7 (1) Someone argues that we should use [ (er t d)/(ud) ] as the risk-neutral

Question:

Exercise 9.6.7 (1) Someone argues that we should use [ (ert −d)/(u−d) ] as the risk-neutral probability thus: Because the option value is independent of the stock’s expected return μ−q, it can be replaced with r . Show him the mistakes. (2) Suppose that we are asked to use the original risk-neutral probability [ (ert −d)/(u−d) ].

Describe the needed changes in the binomial tree algorithm.

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