A Binomial Tree Setting Has an Up-Move Of $u > 1$

question 19

Multiple Choice

A binomial tree setting has an up-move of $u > 1$ (with probability $p = 0.75$ ) and a down move of $d < 1$ (with probability $1 - p = 0.25$ ) ,with $u d = 1$ .The risk-free interest rate per time step is zero,so a dollar invested at the beginning of the period returns a dollar at the end of the period. In this setting,the risk-neutral probability of an up-move

• A)Is \(> \frac { 1 } { 2 }\)
• )
• B)Is \(< \frac { 1 } { 2 }\)
• )
• C)Is equal to \(\frac { 1 } { 2 }\)
• )
• D)Is equal to \(p\)
• )

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Definitions:

Compensating Variation

An economic concept that quantifies the amount of money needed to compensate someone for a policy change, maintaining their original utility level.

Consumption

The process by which goods and services are utilized by individuals or households to satisfy their needs and wants.

Utility Function

A mathematical representation that assigns numerical values to different bundles of goods, showing the satisfaction or utility those goods generate for a consumer.

Equivalent Variation

An economic measure of the difference in income that a consumer would require to reach the same level of utility before and after a price change.