Derivative Pricing 2

Module code: MN3113

This module delves into some of the theoretical underpinnings of financial option pricing. We will first study individual preferences towards risk, distinguishing between risk aversion, risk neutrality and risk attraction. We will also define what a martingale is. We will then study the non-arbitrage theorem (discrete state version), linking it to the existence of risk neutral probability distributions. We will round off the course with derivations of both the binomial option pricing model and the Black-Scholes model. The latter requires knowledge of elementary stochastic processes, which are introduced and briefly analysed.

Topics covered

• Risk preferences
• Risk neutral probabilities
• Non-arbitrage theorem
• Stochastic processes
• Black-Scholes equation