a) Suppose the price of a stock today is 60. The strike prices of call and put options trading on the stock are 60. These options mature in 6 months. The discount risk-free rate is 4% per half annum. The risk- neutral binomial analysis with a time step of 3 months of a European put option produces an option value of 6.18. The downward factor for the lattice model of the stock-price process is 0.779. Identify 1) the risk-neutral probabilities of the binomial tree and 2) the annualized variance of stock returns. Show your calculations. (16 marks)

b) Assuming the standard option inputs (stock price, riskless rate, maturity, strike and volatility) above are unchanged, what behavioural factors would justify an option value of 9.18 for the put option? Explain. (15 marks)