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No more replicating portfolios : a simple convex combination to understand the risk-neutral valuation method for the multi-step binomial valuation of a call option
EuroEconomica
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| Title |
No more replicating portfolios : a simple convex combination to understand the risk-neutral valuation method for the multi-step binomial valuation of a call option
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| Creator |
Mercken, Roger; Hasselt University, Faculty of Business Economics, KIZOK
Motmans, Lisette; Hasselt University, Faculty of Business Economics, ZW Houben, Ghislain; Hasselt University, Faculty of Business Economics, KIZOK |
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| Subject |
investments, stock; Black-Scholes; volatility
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| Description |
This paper covers the valuation, from beginning to implementation, of a European call option on a stock using the multi-step binomial model in a risk-neutral world. The aim is to introduce this model in a simple but rather unconventional way. The usual presentation of the risk-neutral valuation, see Hull (2009), among others, relies on replicating portfolios. For most practitioners, this technique looks rather mysterious. We present a new transparent analysis requiring no replicating portfolios. The new finding to understand why the risk-neutral pricing is consistent with investors being risk-averse is the notion of a convex combination.
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| Publisher |
Danubius University of Galati, Romania
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| Contributor |
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| Date |
2010-04-26
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| Type |
Peer-reviewed Article
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| Format |
application/pdf
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| Identifier |
http://journals.univ-danubius.ro/index.php/euroeconomica/article/view/267
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| Source |
EuroEconomica; Vol 24, No 1 (2010)
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| Language |
en
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| Rights |
The author fully assumes the content originality and the holograph signature makes him responsible in case of trial.
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