One Period Binomial Model: The risk-neutral
probability measure assumption and the state
price deflator approach

Amir Ahmad Dar; N. Anuradha

doi:https://doi.org/10.14445/22315373/IJMTT-V43P531

International Journal of Mathematics Trends and Technology

Research Article | Open Access | Download PDF

Volume 43 | Number 4 | Year 2017 | Article Id. IJMTT-V43P531 | DOI : https://doi.org/10.14445/22315373/IJMTT-V43P531

One Period Binomial Model: The risk-neutral probability measure assumption and the state price deflator approach

Amir Ahmad Dar, N. Anuradha

Citation :

Amir Ahmad Dar, N. Anuradha, "One Period Binomial Model: The risk-neutral probability measure assumption and the state price deflator approach," International Journal of Mathematics Trends and Technology (IJMTT), vol. 43, no. 4, pp. 246-255, 2017. Crossref, https://doi.org/10.14445/22315373/IJMTT-V43P531

Abstract

The aim of this paper is to find the value of the option that provides a payoff at some future date based on the value of a non-dividend paying share at the future date using a Binomial or lattice model to calculate the value of the derivative at time"t=0". We will show that how to find the value of the derivative with the help of the risk-neutral probability (Q) measure and the state price deflator approach.In this report, we compare the value of a call option and put option under the risk neutral valuation (the Q -measure) and the real world valuation (The P-measure). Under the risky neutral probability measure (Q measure) we will see that the expectedreturn on the risky stock is the same as that on risk free investment cash and also it investigates what will happen to the state price deflator A_t ifp>q.

Keywords

Call and Put option, risk-neutral probability, state price deflator (A_t) approach, and Binominal or lattice model, synthetic probability (q).

References

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