Find the price of the european call with strike price

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Question - A stock is trading at $200 with a volatility of 30% per year. Now assume that the volatility next year could be 40% or 20% each with a 50% probability. Assume that the stock and the volatility are independent processes (this is usually not the case). Find the price of the 2-year European call with strike price of $200 using a 2-step tree for the stock. The interest rate is constant at 9%. This extends the CRR model to include stochastic volatility. (Hint: use ideas similar to how we extended CRR to include stochastic rates).

Reference no: EM132182312

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