PPT Slide

Note that 0 < p ə since u > R > d. From

“p” can be interpreted as the risk neutralized probability.

The call price formula is interpreted as the expectation of the

terminal payoff discounted at the risk neutral world.

The parameters u and d are obtained by matching the

volatilities of the discrete random walk process and the

lognormal asset price process. They are given by

where s is the volatility of the asset price process.

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