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 +](https://dsd5zvtm8ll6.cloudfront.net/images/question_images/1700/6/5/7/972655dfb34c27491700657972108.jpg)
where
![O Var[In(Fr(S1)/Fr(S2))]/t for t (0,T].](https://dsd5zvtm8ll6.cloudfront.net/images/question_images/1700/6/5/7/990655dfb461acbc1700657989460.jpg){kind=small}
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)).
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a Since maxS 1 T S 2 T S 1 T S 2 T S 2 T the time0 price of t...View the full answer
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