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Ito's Calculus and the Derivation of the Black-Scholes Option-Pricing ModelGeorge ChalamandarisAthens University of Economics and Business - Department of Accounting and Finance A. G. (Tassos) MalliarisLoyola University of Chicago - Department of Economics 2009 HANDBOOK OF QUANTITATIVE FINANCE, C. F. Lee, Alice C. Lee, eds., Springer, 2009 Abstract: The purpose of this paper is to develop certain relatively recent mathematical discoveries known generally as stochastic calculus, or more specifically as Ito's Calculus and to also illustrate their application in the pricing of options. The mathematical methods of stochastic calculus are illustrated in alternative derivations of the celebrated Black-Scholes-Merton model. The topic is motivated by a desire to provide an intuitive understanding of certain probabilistic methods that have found significant use in financial economics.
Number of Pages in PDF File: 63 Keywords: Ito, Calculus, Derivation, Black, Scholes, Option, Pricing JEL Classification: C02, C60, G13 Accepted Paper SeriesDate posted: October 18, 2007 ; Last revised: February 12, 2009Suggested CitationContact Information
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