STAC70 Statistics & Finance I
\nAssignment 1
\nDue date: Feb 4, 2021 (by 11:59pm). Late submissions will be penalized.
\nNote: For some problems it is more convenient (or even necessary) to use the computer to
\nperform the computations. If you do, perform all computations in R. Include your codes and
\noutputs in your submission.
\n1. Consider the single period binomial model with d < 1 + r < u. Prove from first principles
\n(i.e., without using the fundamental theorems of asset pricing) that there is a unique
\nequivalent martingale measure.
\n2. Consider the single period binomial model. Suppose r = 0.02, u = 1.05, d = 0.9 and
\nS0 = 50. Consider a put option on the stock with strike price K = 49.
\n(a) Compute the equivalent martingale measure (qu, qd).
\n(b) Find the no-arbitrage price of the claim at time 0.
\n(c) Find the replicating portfolio.
\n3. Consider a single period binomial model which satisfies the no-arbitrage condition d <
\n1 + r < u. Consider two contingent claims C and C
\n0 where
\n(cu, cd) = (1, 2) and (c
\n0
\nu
\n, c0
\nd
\n) = (1, 4).
\nYou are given that the no-arbitrage price of C is 1.5, and the no-arbitrage price of C
\n0
\nis 2.
\n(a) Find the interest rate r. Hint: Use the two given claims to generate other cashflows.
\n(b) Find the risk-neutral probabilities qu and qd.
\n4. Write down two different sets of parameters (u, d, r, S0) of the single period binomial
\nmodel which give the same equivalent martingale probabilities. Must they give the same
\nprices for all contingent claims? Explain your reasoning.
\n5. Consider the trinomial model in Example 2.1 of the lecture notes: r = 0, S0 = 1, u = 3,
\nm = 2 and d = 1\/2. Characterize all contingent claims that can be replicated. That is,
\ngive a general expression of the payoffs cu, cm, cd that can be replicated.
\n6. Consider a single-period model with 4 states and 3 risky assets (apart from the risk-free
\nasset). Write \u2126 = {\u03c91, \u03c92, \u03c93, \u03c94}. Assume that
\n(S
\nj
\n0
\n)0\u2264j\u22643 =<\/p>\n
1 1.7 2 2
\nand
\n(S
\nj
\n1
\n(\u03c9i))1\u2264i\u22644,0\u2264j\u22643 =
\n\uf8ee
\n\uf8ef
\n\uf8ef
\n\uf8f0
\n1 1 3 1
\n1 2 3 3
\n1 2 1 1
\n1 1 1 3
\n\uf8f9
\n\uf8fa
\n\uf8fa
\n\uf8fb
\n.
\n1
\n(Here the column index j runs from 0 to 3. So the risk-free interest rate is 0.)
\n(a) Show that the model is arbitrage-free and complete.
\n(b) Consider the contingent claim
\n(C(\u03c9i))1\u2264i\u22644 =
\n\uf8ee
\n\uf8ef
\n\uf8ef
\n\uf8f0
\n1
\n0
\n0
\n1
\n\uf8f9
\n\uf8fa
\n\uf8fa
\n\uf8fb
\n.
\nFind the no-arbitrage price of C at time 0 and find a replicating portfolio. Is the
\nreplicating portfolio unique?
\n7. Consider the gambling strategy in Example 3.2 of the lecture notes, where the initial
\nwealth is 0. Find the exact distribution of the wealth M10 at time t. (This means finding
\nthe probability mass function P(M10 = x) for the possible values of x.) Verify numerically
\nthat E[M10] = 0.
\n2<\/p>\n
—-<\/p>\n
Assignment 1 for STAC70 Statistics & Finance I<\/p>\n
The deadline is February 4, 2021. (by 11:59pm). Late submissions will incur penalties.<\/p>\n
Nota bene: For some situations, it is more convenient (or perhaps required) to utilize a computer to solve them.<\/p>\n
carry out the calculations If you do, make sure to do all of your calculations in R. Include all of your codes and<\/p>\n
in your submission’s outputs<\/p>\n
1. Take a look at the single period binomial model with d 1 + r u. Prove it from the ground up.<\/p>\n
(i.e., without using the fundamental theorems of asset pricing) that there is a unique<\/p>\n
equivalent martingale measure.<\/p>\n
2. Consider the single period binomial model. Suppose r = 0.02, u = 1.05, d = 0.9 and<\/p>\n
S0 = 50. Consider a put option on the stock with strike price K = 49.<\/p>\n
(a) Compute the equivalent martingale measure (qu, qd).<\/p>\n
(b) Find<\/p>\n","protected":false},"excerpt":{"rendered":"
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