CiD_April 99, q5. Hull 5th edition?

[Edwin]

The model solution uses Chapter 19.3 (alternatives to the Black Scholes) of Hull 5th edition which uses both the graphs in the model answer and a triad to distinguish between the pricing bias due to variations in the thickness of tails.

However, ACTED suggests we look at the question. I would think that in ST6 today (with 8th Edition Hull) the solution in the examiner's report does not apply since the 8th edition does not cover Pricing bias. Furthermore, should we solve this question now, the solution will be too general ;-

1) for ten marks (few points to expand on)
2) and to capture specifically the pricing of calls and puts as is done by the Examiner's solution.

In other words, this was a 5th edition bookwork question, should we still focus on it?

 

[Mike Lewry]

The question is still a good one to think about, but I agree that expecting a solution from Hull 5th edition or earlier would be unreasonable!

Make sure you're clear on how the tails of the actual distribution would affect the accuracy of the Black-Scholes price (considering out-of-the-money call and put options is a good approach) and then move on.