by mikek » Tue Jun 12, 2012 2:24 pm
Did not want to start a separate section for this. I have two questions - both of them apply equally to all parts of this question so I will just use part 1 as an example:
1) When I am looking at the payoff graph I can say that super-replicating portfolio has to go through points 0 and 110. What I do not understand is why I cannot (and should not) use the alternative upper bound method used in example on p.39 of 2nd edition of book? Using this method the upper boundary would be min(super-replicating portfolio, P), where P is the cost of zero-coupon bond expiring at time of maturity of the option.
2) While my solution matches what was posted I do not use the cost constraint and I do not really understand the importance of having to consider the cost constraint. Is there an example where the constraint I am ignoring would make a difference in finding the super-replicating portfolio?