Ito's Calculus and the Derivation of the Black-Scholes Option-Pricing Model
HANDBOOK OF QUANTITATIVE FINANCE, C. F. Lee, Alice C. Lee, eds., Springer, 2009
63 Pages Posted: 18 Oct 2007 Last revised: 12 Feb 2009
Date Written: 2009
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.
Keywords: Ito, Calculus, Derivation, Black, Scholes, Option, Pricing
JEL Classification: C02, C60, G13
Suggested Citation: Suggested Citation