Titlebook: Smile Pricing Explained; Peter Austing Book 2014 Palgrave Macmillan, a division of Macmillan Publishers Limited 2014 Volatility smile.Impl

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Dynamic Hedging and Replication,in the underlying asset and bonds. We do not know if this value is unique, or failing that in any way optimal. With what we have learned so far, a trader could take on a new contract in a large notional amount and value it in a manner guaranteed to avoid arbitrage. All very well, but that does not h

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,Exotic Options in Black—Scholes,ntracts that can be valued analytically or semi-analytically. These formulas are all very useful for risk management. A typical portfolio of options managed by a single trader consists of thousands of trades. In order for the trader to understand his or her position, the entire book must be valued o

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Smile Models,ms. For this to work, both counterparties have first to agree on the values of the inputs to the Black—Scholes equation, namely the forward and interest rate. Then if the seller quotes a volatility of 10% for the given contract, the buyer will plug this into the Black—Scholes formula to get the pric