An Introduction to the Mathematics of Financial Derivatives by Salih N. Neftci, Ali Hirsa

By Salih N. Neftci, Ali Hirsa

An advent to the maths of economic Derivatives is a well-liked, intuitive textual content that eases the transition among uncomplicated summaries of monetary engineering to extra complicated remedies utilizing stochastic calculus. Requiring just a uncomplicated wisdom of calculus and chance, it takes readers on a journey of complex monetary engineering. This vintage identify has been revised via Ali Hirsa, who accentuates its recognized strengths whereas introducing new topics, updating others, and bringing new continuity to the complete. well-liked by readers since it emphasizes instinct and customary feel, An advent to the maths of economic Derivatives is still the one "introductory" textual content which can attract humans outdoors the math and physics groups because it explains the hows and whys of sensible finance problems.

- allows readers' realizing of underlying mathematical and theoretical versions through providing a mix of conception and functions with hands-on learning
- provided intuitively, breaking apart complicated arithmetic ideas into simply understood notions
- Encourages use of discrete chapters as complementary readings on diverse themes, providing flexibility in studying and educating

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Additional info for An Introduction to the Mathematics of Financial Derivatives (3rd Edition)

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8 REFERENCES In this chapter, arbitrage theorem was treated in a simple way. Ingersoll (1987) provides a much more detailed treatment that is quite accessible, even to a beginner. Readers with a strong quantitative background may prefer Duffie (1996). The original article by Harrison and Kreps (1979) may also be consulted. Other related material can be found in Harrison and Pliska (1981). The first chapter in Musiela and Rutkowski (1997) is excellent and very easy to read after this chapter. 9 APPENDIX: GENERALIZATION OF THE ARBITRAGE THEOREM According to the arbitrage theorem, if there are no-arbitrage possibilities, then there are “supporting”state prices {ψi }, such that each asset’s price today equals a linear combination of possible future values.

3 A NUMERICAL EXAMPLE A simple example needs to be discussed. 59) Clearly, at the observed value for the call premium, C = 25, it is impossible to find ψ1 and ψ2 that satisfies all three equations given by the arbitrage-free representation. Arbitrage opportunities therefore exist. 2 Case 2: Arbitrage-Free Prices In order to determine the arbitrage-free value of the call premium C, one would need to select the “correct”ψi . In principle, this can be done using the underlying economic equilibrium.

The theorem also gives the form of these probability distributions. Further, the notion of martingales is essential to Girsanov theorem, and, consequently, to the understanding of the “risk-neutral” world. Finally, there is the question of how to relate the movements of various quantities to one another over time. In standard calculus, this is done using differential equations. In a random environment, the equivalent concept is a stochastic differential equation (SDE). Needless to say, in order to attack these topics in turn, one must have some notion of the well-known concepts and results of “standard” calculus.

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