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c c
A c = A
A c = A
is n correlatio where on distributi
normal standard bivariate a from
samples random are and where
2 1
2 2
1 1
t z
t z
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
24
I ts Lemma (See pages 313-315)
If we know the stochastic process followed
by x, Its lemma tells us the stochastic
process followed by some function G (x, t ).
When dx=a(x,t) dt+b(x,t) dz then
Since a derivative is a function of the price of
the underlying asset and time, Its lemma
plays an important part in the analysis of
derivatives
2
2
2
G G G G
dG a b dt b dz
x t x x
c c c c
c c c c
| |
= + + +
|
\ .
Indication of Why Its Lemma
is True
A Taylors series expansion of G(x, t)
gives
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
25
+ A
c
c
+ A A
c c
c
+
A
c
c
+ A
c
c
+ A
c
c
= A
2
2
2 2
2
2
2
t
t
G
t x
t x
G
x
x
G
t
t
G
x
x
G
G
\
|
c
c
+
c
c
+
c
c
=
+ =
c
c
+
c
c
+
c
c
=
2
2
2
2
2
2
Application of I ts Lemma
to a Stock Price Process
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
30
dz S
S
G
dt S
S
G
t
G
S
S
G
dG
t S G
z d S dt S S d
and of function a For
is process price stock The
o
c
c
+
|
|
.
|
\
|
o
c
c
+
c
c
+
c
c
=
o + =
2 2
2
2
Examples
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
31
dz dt dG
S G
dz G dt G r dG
e S G
T
t T r
2
price stock a of log The 2.
time at maturing
contract a for stock a of price forward The 1.
2
o +
|
|
.
|
\
|
o
=
=
o + =
=
ln
) (
) (