ECON 322 Study Guide - Final Guide: Corporate Bond, Random Walk Hypothesis, Bond Duration
10 May 2016
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1. you should know how to derive the binomial option pricing model as in. Eg for 3 dates, t = 0, 1, 2. Understand how the binomial model approximates the black-scholes model formula as the number of trading times increases. (i am interested in intuition rather than a proof. ) The binomial option pricing model for 3 dates is easy. Remember that proof and remember speci cally that the t=2 version is. The reason that the binomial option pricing theory approximates the black scholes. Option pricing theory is the way time breaks down as t in nite. In the binomial option theory, one of two movements can occur once a period. Basically, it is a very discrete time based idea. As we have t in nite, the discrete time becomes a lot closer to continuous time. This results in both u and d being distributed normally, as opposed to previously where they were distributed binomially.
