919 Stock Expected Return using Pseudo-Probabilities What is the stocks expected return using these pseudo-probabilities? E(Sr)= pSou+(1- p)sod= pSou+ sod- psod pSou- psod+ sod= pso(u-d)+ sod S。(l-d)+Sd (e-d)so sod d+sd Thus, the expected return on the stock is the risk-free rate even though the return has some variance, Hence we are in a risk-neutral world Options, Futures, and Other Derivatives, 4th edition@ 2000 by John C. Hull Tang Yincai, Shanghai Normal UniversityOptions, Futures, and Other Derivatives, 4th edition © 2000 by John C. Hull Tang Yincai, Shanghai Normal University 9.19 Stock Expected Return using Pseudo-Probabilities • What is the stock’s expected return using these pseudo-probabilities? • Thus, the expected return on the stock is the risk-free rate even though the return has some variance. Hence, we are in a risk-neutral world. r t r t r t r t T S d S S d S S d S d S u d S d u d d pS u pS d S d pS u d S d E S pS u p S d pS u S d pS d e (e ) e ( ) e ( ) ( ) (1 ) 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 = = − + = − + − + − − = = − + = − + = + − = + − u d d p rt − − = e •