Option Binomial always, checked, presented, material

hw0799

So, the Schweser material says that you calculate a down move at 1/U while in the CFAI EOC they always tell you that the up is 20% and down is say, 15%. In the few cases that I checked the CFAI material down never equaled 1/U.

Does anyone know how this will be presented on the exam?

5566

This is obviously wrong in Schweser's. There is no choice here, this is straightforward. If a stock is at $100 and it can go up by 15% or down by 10%, then it can only have these two values: Either 115 or 90. You are always told what these percentages are.

chaojimali

Well don't I feel stupid.

So the original poster is basically questioning why Schweser's method gives the down move size as .87 instead of .85.

needhelp1700

For example, if they give you the size of an up move as 1.33 then the formula would come out (let's say risk free rate is 5%)

1+.05-(1/1.33) / 1.33-.75 = .51 So the risk neutral probability of an up move (pi) is 51%

If they give the movement size as a percent, the above formula doesn't work. So how do you do it when they give the movement size as a percent instead.

kkn006

Well, if the stock goes up by 15%, the size is 1+ 0.15 = 1.15
If it goes down by 15%, the size is 1-0.15 = 0.85

Helps?

chandsingh

I want to know how you calculate Pi when the size of the movements isn't given in decimal form (like 1.33), and is instead given in percentage form (like 15%).

yalo

^ are you talking about the "size of movements" or the probabilities (Pi up, Pi Down). Because the formula you mentioned above is used to calculate the Pi

SeanWest

So how do you calculate the risk neutral probabilities if they give you the size of the up move as a percent? Let's say the size of an up move is 40% for example? It doesn't work to use the formula I have which is 1+Rf-D/U - D

lucasg85

I know that Schweser uses D = 1/U. I think that's incorrect.
On the exam, you'll likely be given the size of the up and down movements just like the CFAI text does.

In real life, size of up and down moves are calculated using permutation.



Edited 1 time(s). Last edit at Wednesday, May 18, 2011 at 03:53PM by Iginla2010.

ppls

from what i know, its just about how you decide to model volatility

a common way is to do down=1/up

CFAI could be using some other model and giving you the up and the down, so just use what they give you