(Answered) State pricing theory and no-arbitrage pricing theory

Finance

State pricing theory and no-arbitrage pricing theory.

(1) ψ₁ and ψ₂ are prices. What do they price?

(2) What is the required condition that ψ₁ and ψ₂ must satisfy to prevent arbitrage opportunities between the securities in a state pricing representation?

(3) The current traded price of an underlier is $10, and it may be either $5 or $15 at the end of the period. Riskless borrowing and lending for the period is 10% p.a. A European vanilla Put option on the underlier with strike price of $9 is trading in the market. What is the no-arbitrage value of the European vanilla Put option?

(4) What is the risk neutral probability for state 1?

(5) When valuing a risky derivative with no-arbitrage methods, why can we discount its expected end-of-period payoff at the riskless rate?

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