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?

Hi there!They are different models:1. Binomial model - Uses up and down risk-adjusted probabilitiesUp probability = 1+Rf-D/U-D2. 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 Stock3. 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.

A CFA Level 2 Discussion About CFA Lvl 2 Derivatives. Risk Neutral, No Arbitrage

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This topic has 1 reply, 2 voices, and was last updated Mar-1911:29 am by ec_test.

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- ec_test
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  27 Mar 2019 at 11:29 am
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  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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