18.642 | Fall 2024 | Undergraduate

Topics in Mathematics with Applications in Finance

Lecture 21: Black-Scholes Formula, Risk Neutral Valuation

This lecture explores the fundamental concept of risk-neutral pricing as a powerful framework for derivative valuation, illustrated through examples like forward contracts and options. It further explains the derivation of the Black-Scholes equation from stochastic calculus, highlighting how derivative prices depend primarily on volatility and interest rates, not on investors’ risk preferences, and concludes with practical insights into option replication and hedging strategies.

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