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the importance of Itô’s lemma for derivative pricing

the importance of Itô’s lemma for derivative pricing

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Importance of ito’s lemma for derivative pricing:

The ito lemma is used to determine derivatives of time independent function of stochastic processes. This is an application that is widely used for derivation of black schools equation. Its major advantage includes its benefit of relating the change in the price of the derivative security to the change in the underlying asset. Ito lemma is also applied to geometric Brownian motion, asset price processes, Brownian bridge processes etc.

Ito lemma also provides a way to construct a new SDE i.e. stochastic differential equations.

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