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Exercises 8

The document contains exercises related to financial mathematics, specifically focusing on options pricing, including Delta and Gamma calculations for call and put options. It also explores the pricing of binary options using binomial models and provides identities for expected values of certain derivatives. Additionally, it discusses properties of monotonic and convex functions in relation to European vanilla derivatives.

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gameom260
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5 views

Exercises 8

The document contains exercises related to financial mathematics, specifically focusing on options pricing, including Delta and Gamma calculations for call and put options. It also explores the pricing of binary options using binomial models and provides identities for expected values of certain derivatives. Additionally, it discusses properties of monotonic and convex functions in relation to European vanilla derivatives.

Uploaded by

gameom260
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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INTRODUCTION TO FINANCIAL MATHEMATICS

Exercise sheet 8

Exercise 36 Show that the Delta of a call and a put option satisfy the following equality
∆call − ∆put = 1.
Moreover, show that the Gamma of a call and a put option satisfy the following equality
Γcall = Γput .

Exercise 37 Show that the Gamma and Rho of a call option in the Black–Scholes model equal
∂ ∂2 1
Γ= ∆BS = 2 v BS (S0 , K, r, T, σ) = √ φ(d1 )
∂S0 ∂ S0 Sσ T
and
∂ BS
P= v (S0 , K, r, T, σ) = KT e−rT Φ(d2 ),
∂r
where v BS denotes the Black–Scholes formula for the price of a call option and ∆BS its Delta.

Exercise 38 Consider
√ the sequence of binomial
√ asset pricing models defined in the lecture, with parameters rn := r∆n ,
an := r∆n − σ ∆n and bn := r∆n + σ ∆n , where σ > 0 and ∆n := T /n. We would like to compute the arbitrage-
free prices of the following binary options (these are options with discontinuous payoff functions), as the limit of the
arbitrage-free prices in the binomial models. Let K > 0 be a fixed constant.
(i) A cash-or-nothing call C with payoff C := 1{ST >K} . Define C0n to be the arbitrage-free price at time 0 in the n-th
binomial model. Compute the limit limn→∞ C0n .
(ii) An asset-or-nothing put P with payoff P := ST 1{ST <K} . Define P0n analogously to (i). Compute the limit
limn→∞ P0n .
(iii) A gap option G with payoff G := (ST − c)1{ST >K} for a fixed c > 0. Define Gn0 analogously to (i). Compute the
limit limn→∞ Gn0 .
(iv) Compute the price of the gap option using the prices of the cash-or-nothing and the asset-or-nothing options, i.e.
without taking limits.

Exercise 39 Use the following identity, for α > 1


Z ∞
xα = α(α − 1) (x − K)+ K α−2 dK
0

and Fubini’s Theorem to show that


Z ∞
E STα = α(α − 1) E[(ST − K)+ ]K α−2 dK.
 
0

Use this identity and the formula for the price of a call option in the Black–Scholes model in order to compute the price
of a derivative with payoff
C = STα .

Exercise 40 Consider a European vanilla derivative C := f (XT ) with payoff function f : R+ → R+ at time point T ,
where XT denotes the discounted asset price at T . Let π̂t denote the arbitrage-free, discounted derivative price at time
point t ∈ {0, . . . , T } and (ξt )t=1,...,T denote the associated position in the asset in the replicating strategy.
We know from the lectures that the following hold:
π̂t = vt (Xt ) and ξt = ∆t (Xt−1 )
for suitable functions vt , ∆t : R → R.

1
(i) Show that: if f is monotone, then the functions (vt )t=0,...,T have the same monotonicity. Then, deduce that: if the
function f is monotone increasing (decreasing), then ∆t ≥ 0 (∆t ≤ 0).
(ii) Show that: if f is convex, then vt is also convex, for every t ∈ {0, . . . , T }.

(iii) Show that: if f is convex, then there exist constants ℓ and L, such that, for every t ∈ {0, . . . , T }, holds

ℓ L
≤ ∆t (x) ≤ for al x ∈ R+ .
(1 + r)T (1 + r)T

Hint: use the following results on convex functions as well as that EQ [Rt ] = r.
(iv) What can you say concretely in (i) and (iii) for European call and put options?

Results on convex functions: Let f : R+ → R+ be a convex function.


(i) Let x, y, z ∈ R+ with x < y < z, then holds:

f (y) − f (x) f (z) − f (x) f (z) − f (y)


≤ ≤ .
y−x z−x z−y

(ii) The following limits exist:


f (x) f (x) − f (0)
L := lim und ℓ := lim .
x→+∞ x x→0 x
(iii) Let x, y ∈ R+ with x < y, then holds:
f (y) − f (x)
ℓ≤ ≤ L.
y−x

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