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CFA Lvl 2 Derivatives. Risk Neutral, No arbitrage

Hi guys,

Little confused about some of the derivatives stuff. What is the difference or the relationship between the risk neutral probability model of valuing calls puts, and the no arbitrage, and expectations approaches. Should they be considered as separate models?


  • ec_testec_test USAPosts: 38 Sr Associate
    edited April 2017
    Hi there!

    They are different models:

    1. Binomial model - Uses up and down risk-adjusted probabilities
    Up probability = 1+Rf-D/U-D

    2. When you say the "no-arbitrage," model I'm assuming you mean the European Put-Call Parity equation from which you could derive the price of a call or a put.

    C0 + PV(Bond)=P0 + Long Stock

    3. Expectation approach - It is the Black-Scholes-Merton Model

    Yes, they are different models and the vignettes will generally tell you which model to use to calculate the value of the call or put.   
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