How can we use real probabilities for pricing derivatives
How can we use real probabilities for pricing derivatives?
Expert
Yes and no. There are many reasons why risk-neutral pricing does not work perfectly in practice, since markets are incomplete and dynamic hedging is not possible. If you cannot continuously dynamically hedge so you cannot remove risk and so risk neutrality is not too relevant. You might be tempted to try to price by using real probabilities in its place. It is fine, and there are plenty of theories on such topic, generally with some element of utility theory regarding them. For illustration, some theories exercise concepts from Modern Portfolio Theory and look at real averages and real standard deviations.
Example of Forward and Backward Equations.
Describe balance of payments identity and explain its implication under the fixed & flexible exchange rate regimes.The balance of payments identity holds that the combined balance on the current & capital accounts have to be equivalent i
Who introduced equity option formula for pricing interest rate options?
Will the cost of equity be zero if dividends paid to common stockholders will not be legal obligations of a corporation?
How are financial or economic variable represented by index?
How many assumptions are made to find a taxi?
What are the ways to build-up the volatility effect in an option-pricing?
Explain in brief about financial ratio?
Explain the term functional form of coefficients in finite-difference methods.
Normal 0 false false
18,76,764
1957137 Asked
3,689
Active Tutors
1447091
Questions Answered
Start Excelling in your courses, Ask an Expert and get answers for your homework and assignments!!