Question

Which of the following is false based on binomial option pricing model?

Group of answer choices

The future value interest factor should be less than the multiplicative upward movement of the stock price

The risk neutral probability does not depend on the underlying asset volatility

The cost of synthetic option should be equal to option premium in absence of arbitrage

A four-period binomial option pricing model should have five possible underlying asset prices at the maturity

Answer 1

Solution.>

The correct option is (B) ie. The risk neutral probability does not depend on the underlying asset volatility

The risk neutral probability does depend upon the volatility of the underlying asset.

Risk neutral probability : p = e^rt - d / u - d

Here, r: risk free rate

t = time of one period

d = e^(-volatilty * Sqrt(t))

u = e^(volatilty * Sqrt(t))

Hence, p depends upon the volatility of the underlying stock.

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