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Intermediate Financial Theory, 3rd Edition by John B. Donaldson, Jean-Pierre Danthine

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Chapter 13

The Martingale Measure

Part II

Chapter 13 applies the technique of risk neutral valuation first to the setting of the Consumption CAPM and then to the context of derivative security valuation. The binomial options pricing perspective is developed, and illustrated with examples. The Black-Scholes pricing formula for an equity call option is introduced and its connection to binomial pricing discussed.

Keywords

Risk-neutral valuation; CCAPM; Dybvig’s evaluation; Black–Scholes formula; risk-neutral probabilities; binomial options pricing

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