Dirivatives – Essay Excellence

MSc IN MATHEMATICAL TRADING AND FINANCE

COURSEWORK This is a group coursework (groups of up to 4 students). Submissions have to be made by Monday the 30th of March 2015 (16:00 hours). Maximum number of words 3,000 The coursework aims to test your understanding and intuition. Make sure that your answers are as detailed and complete as possible. make explicit assumptions where you think is necessary. This is not a coursework to test primarily your com- putational skills by producing a solid code, rather an exercise in solving ?nancial issues; therefore the platform will be Excel. You are asked to build a Derman and Kani- type (binomial ) implied arbitrage- free volatility tree. The number of periods will be ?ve. You may use options on any asset class, as long as they are liquid (options on stock market indices such as S&P 500 are quite suitable) for any period from 2010 onwards. Make sure that you take care of dividends ( if applicable), early optionality (eg., American options, if applicable). Provide details of the interpolation/extrapolation methods to con- struct the input option/implied volatility data. Make explicit assumptions about centering the tree and construct also the implicit Arrow-Debreu tree. Discuss how you handle “bad probabilities”, i.e., violations of the no-arbitrage condition. As a baseline, you should construct a similar constant volatility binomial tree (for example, Cox-Ross-Rubinstein). Calculate the “Greeks” and compare them

with your ?ndings from the implied volatility tree. Discuss your ?ndings.

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