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AMATH 460: Mathematical Methods

for Quantitative Finance


3. Partial Derivatives
Kjell Konis
Acting Assistant Professor, Applied Mathematics
University of Washington
Kjell Konis (Copyright 2013)

3. Partial Derivatives

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Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

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Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

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Scalar Valued Functions


A function of several variables that takes values in R is called a
scalar valued function.
Notation: f : Rn R
y R,

y = f (x1 , x2 , . . . , xn )

xj R for j = 1, . . . , n

Example: Black-Scholes Formula for a European Call Option Price


Inputs:

S
K
T
t

asset price
strike price
maturity
time

r
q

asset volatility
risk-free interest rate
asset continuous dividend rate

C (S, t; ) =


S e q(T t) d+ (S, t; ) K e r (T t) d (S, t; )
log

d+ (S, t; ) =
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S
K

+ r q + 2 (T t)

, d (S, t; ) = d+ (S, t; ) T t
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T 3. tPartial Derivatives

Partial Derivatives
Let f : Rn R
The partial derivative of f with respect to xj is denoted by
f
xj (x1 , . . . , nn ) and is defined as
f
f (x1 , . . . , xj1 , xj + h, xj+1 , . . . , xn ) f (x1 , . . . , xn )
() = lim
h0
xj
h
if the limit exists and is finite.

In practice, to compute

f
xj

fix xk for k 6= j
differentiate f as a function of one variable xj
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3. Partial Derivatives

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Example

f (x , y ) = x 2 y + e xy

f (x , y ) =
x

 2
 xy 3 
yx +
e
x
x

= y

 u
 2
x +
e
x
x

= 2xy + e u

u
= y 3
x

u
x

= 2xy y 3 e xy

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let u = xy 3

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Example (continued)

f (x , y ) = x 2 y + e xy

f (x , y ) =
y

 2
 xy 3 
yx +
e
y
y

= x2

 
 u
y +
e
y
y

= x 2 + eu

u
y

= x 2 3xy 2 e xy

Kjell Konis (Copyright 2013)

let u = xy 3

u
= 3xy 2
y
3

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The Gradient

Let f (x ) = f (x1 , . . . , xn ) : Rn R. The gradient of f (x ) is denoted


by D f (x ) and is defined to be the following 1 n array of partial
derivatives.


D f (x ) =

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f
x1

f
x2

3. Partial Derivatives

f
xn

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Vector Valued Functions


A function of one or several variables that takes values in a
multidimensional space is called a vector valued function.
Notation: f : Rn Rm

f1 (x1 , . . . , xn )

f2 (x1 , . . . , xn )

f (x1 , . . . , xn ) =
..

fm (x1 , . . . , xn )

Partial derivatives have the form


fi
(x1 , . . . , xn )
xj
There are n m first-order partial derivatives in total. Yikes!
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3. Partial Derivatives

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Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

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Higher Order Partial Derivatives


For functions of a single variable:


d2
d 0
d d
f (x ) =
f (x ) = f 00 (x )
f (x ) =
2
dx
dx dx
dx
For functions of several variables:
2 xy
e
x 2

xy
 xy 

e
=
ye
= y e xy = y 2 e xy
x x
x
x

2 xy
e
y 2

xy
 xy 

e
=
xe
= x e xy = x 2 e xy
y y
y
y

For functions of several variables also have mixed partial derivatives:


2 xy
e
x y

xy
 xy 

e
=
xe
= e xy + x e xy = e xy + xy e xy
x y
x
x


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3. Partial Derivatives

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Mixed Partial Derivatives


What is the relationship between

Already saw that


2 xy
e
y x

2 xy
e = e xy + xy e xy
x y

xy
 xy 

e
=
ye
= e xy + y e xy = e xy + xy e xy
y x
y
y


2
2
and
?
x y
y x

For f (x , y ) = e xy have
2f
2 xy
2 xy
2f
=
e = e xy + xy e xy =
e =
x y
x y
y x
y x
But, f (x , y ) = e xy has a certain symmetry wrt differentiation
Lets see what happens when f (x , y ) = x 2 y + e xy
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Mixed Partial Derivatives


2f
x y



 2
3
x y + e xy
x y

u
x2 +
e
x
y

x 2 + eu
x
y

i
h 2
3
x 3xy 2 e xy
x

= 2x 3y 2 e xy + 3xy 2

let u = xy 3

u
= 3xy 2
y

u
e
x

u
x

= 2x 3y 2 e xy 3xy 2 e u

= 2x 3y 2 e xy + 3xy 5 e xy
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3. Partial Derivatives

u
= y 3
x

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Mixed Partial Derivatives


2f
y x



 2
3
x y + e xy
y x

u
2xy +
e
y
x

u
2xy + e u
y
x

=
=

i
h
2xy y 3 e u
y

2 xy 3

= 2x 3y e

u
= y 3
x

u
+y
e
y
3

= 2x 3y 2 e xy y 3 e u

u
y

= 2x 3y 2 e xy + 3xy 5 e xy
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let u = xy 3

3. Partial Derivatives

u
= 3xy 2
y
3
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Mixed Partial Derivatives


3

When f (x , y ) = x 2 y + e xy have
2f
2f
3
3
= 2x 3y 2 e xy + 3xy 5 e xy =
x y
y x

Theorem If all of the partial derivatives of order k of the function


f (x ) exist and are continuous, then the order in which partial
derivatives of f (x ) of order at most k are computed does not matter.

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The Hessian
Let f (x ) = f (x1 , . . . , xn ) : Rn R. The Hessian of f (x ) is denoted
by D 2 f (x ) and is defined to be the following n n array of (mixed)
partial derivatives.

2f
x12

2f

x x
1 2

2
D f (x ) =

..

2f

x1 xn
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2f
x2 x1
2f
x22

..
.

..

2f
x2 xn

3. Partial Derivatives

2f
xn x1

2f

xn xn

..

xn2

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Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

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Functions of Two Variables


Let f = f (x , y ) : R2 R be a scalar-valued function
The partial derivatives of f are also functions of x and y :
f
(x , y ) =
x

f (x + h, y ) f (x , y )
h0
h

f
(x , y ) =
y

f (x , y + h) f (x , y )
h0
h

lim

lim

The gradient of f (x , y ) is
f
D f (x , y ) =
(x , y )
x


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3. Partial Derivatives

f
(x , y )
y

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Functions of Two Variables

The Hessian of f (x , y ) is
2f
(x , y )

2x

D 2 f (x , y ) =

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2f
(x , y )
x y

3. Partial Derivatives

2f
(x , y )

y x

2f
(x , y )
2y

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Example
Let f (x , y ) = x 2 y 3 . Evaluate D f and D 2 f at the point (1, 2)
f
(x , y ) = 2xy 3
x
f
(x , y ) = 3x 2 y 2
y
2f
(x , y ) =
x 2
2f
(x , y ) =
x y
2f
(x , y ) =
y 2
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f
(x , y ) =
2xy 3 = 2y 3
x x
x


f
 2 2
2f
(x , y ) =
3x y = 6xy 2 =
(x , y )
x y
x
y x


 2 2
f
(x , y ) =
3x y = 6x 2 y
y y
y


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Example (continued)


D f (x , y ) =
D f (1, 2) =

f
(x , y )
x

2f

x 2

D f (x , y ) =

D f (1, 2) =
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2 1 23


f
(x , y ) = 2xy 3
y

"

2f
x y

3x 2 y 2

3 12 22 = 16 12


2f

y x

2f
y 2

"

2y 3 6xy 2
6xy 2 6x 2 y

2 23
6 1 22
2
6 1 2 6 12 2
3. Partial Derivatives

"

16 24
24 12

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Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

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Chain Rule for Functions of a Single Variable


Let f (x ) be a differentiable function
Let x = g(t) where g(t) is a differentiable function
f (x ) can be thought of as a function of t: f (x ) = f (g(t)), and
df dx
df
=
dt
dx dt
Example: evaluate

d
log(cos(t))
dt

Let f (x ) = log(x ), x = cos(t)



df dx
1
1
df
d
=
sin(t) =
sin(t) = tan(t)
= f (x ) =
dx dt
x
cos(t)
dt
dt

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Chain Rule for Functions of 2 Variables


Let f (x , y ) be a differentiable function
Let x = g(t) and y = h(t) where g and h are differentiable functions


f (x , y ) = f g(t), h(t) is a function of t and





df
f
f
g(t), h(t) =
g(t), h(t) g 0 (t) +
g(t), h(t) h0 (t)
dt
x
y

Using Leibniz notation:


df
f dx
f dy
=
+
dt
x dt
y dt

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3. Partial Derivatives

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Example
Let f (x , y ) = x 2 + y + xy 3 , x = e 2t , and y = t 2
First, by direct computation
f (t) = e 4t + t 2 + t 6 e 2t


d
f (t) = 4e 4t + 2t + 6t 5 e 2t + t 6 2e 2t
dt

df
dt

= 2t 6 e 2t + 6t 5 e 2t + 2t + 4e 4t

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Example (continued)
Again, using the chain rule
f (x , y ) = x 2 + y + xy 3
f
x

= 2x + y 3

f
= 1 + 3xy 2
y

dx
dt

= 2e 2t

dy
= 2t
dt

d
f (x , y ) =
dt

f dx
f dy
+
= (2x + y 3 ) 2e 2t + (1 + 3xy 2 ) 2t
x dt
y dt

= (2e 2t + t 6 ) 2e 2t + (1 + 3t 4 e 2t ) 2t
= 2t 6 e 2t + 6t 5 e 2t + 2t + 4e 4t
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Chain Rule for Functions of 2 Variables


Let f (x , y ) be a differentiable function
Let x = g(s, t) and y = h(s, t) where g and h are differentiable
f (x , y ) = f (g(s, t), h(s, t)) is a function of s and t
f
s

f
t

f x
f y
+
x s
y s

f h
f g
+
x s
y s

f x
f y
+
x t
y t

f g
f h
+
x t
y t

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Chain Rule for Functions of n Variables

In general, let f = f (x1 , . . . , xn ) be a function of n variables


For i = 1, . . . , n, let xi = xi (t1 , . . . , tm ) be functions of m variables
The partial derivative of f wrt tj is
n
X
f xi
f
=
tj
x
i tj
i=1

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3. Partial Derivatives

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Example
f (x1 , x2 , x3 ) = x12 + x1 x2 + x1 x3 + 2x32
x1 (t1 , t2 ) = t12 t22 + 1, x2 (t1 , t2 ) = t22 + t1 + 1, x3 (t1 , t2 ) = t12 1
Compute

f
t1

f
t1

f x1
f x2
f x3
+
+
x1 t1
x2 t1
x3 t1

= (2x1 + x2 + x3 )(2t1 ) + (x1 )(1) + (x1 + 4x3 )(2t1 )


= (2t12 2t22 + 2 + t22 + t1 + 1 t12 1)(2t1 )
+(t12 t22 + 1) + (t12 t22 + 1 4t12 4)(2t1 )
= (t12 t22 + t1 + 2)(2t1 ) + (t12 t22 + 1) + (3t12 + t22 + 3)(2t1 )
= 8t13 + 3t12 + 10t1 t22 + 1
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3. Partial Derivatives

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Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

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Implicit Functions
So far, functions have expressed one variable in terms of another (or
others), e.g.,
y = f (x ) =

1 x2

or

y=

sin(x )
x

An implicit function is defined by a more general relation between the


variables, e.g.,
x2 + y2 = 1

or

x 3 + y 3 = 6xy

In some cases, possible to solve for one variable as an explicit function


(or functions) of the others.
Terminology: let F (x , y , z) be a function of 3 variables. The set of
points that satisfy
F (x , y , z) = 0
is called the locus defined by F .
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3. Partial Derivatives

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Implicit Functions
Circle

Folium

x2 + y2 = 1

x 3 + y 3 = 6xy

1 x2

red curve: y = 1 x 2
blue curve: y =

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blue curve: more difficult . . .

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Circle
Slope of tangent line to the unit circle
Case 1: blue curve y 0

Case 2: red curve y < 0

d
y
dx

d p
1 x2
dx

dy
dx

1
d
(1 x 2 ) 2
dx

1
1
(1 x 2 ) 2 (2x )
2

d
y
dx

i
d h p
1 x2
dx

dy
dx

i
1
d h
(1 x 2 ) 2
dx

x
1 x2

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1
1
= (1 x 2 ) 2 (2x )
2

3. Partial Derivatives

1 x2

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Derivatives of Implicit Functions Using the Chain Rule


Recall that if y is a function of x then the chain rule says
d 2
d  2  dy
dy
y =
= 2y
y
dx
dy
dx
dx
x2 + y2 = 1

d  2
x + y2 =
dx

2y

d
1
dx

d 2
d 2
x +
y = 0
dx
dx
2x + 2y

dy
dx

= 0

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3. Partial Derivatives

dy
dx

= 2x

dy
dx

x
y

x
1 x2

(y 0)

1 x2

(y < 0)
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Example
Compute

dy
dx

for the Folium

x 3 + y 3 = 6xy

d  3
x + y3 =
dx


d 
6xy
dx

d  3
d  
d  3
= 6y + 6x
x +
y
y
dx
dx
dx
3x 2 + 3y 2

dy
dx

= 6y + 6x

(3y 2 6x )

dy
dx

= 6y 3x 2

dy
dx

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dy
dx

2y x 2
y 2 2x
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Example (continued)

dy
2y x 2
= 2
dx
y 2x

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3. Partial Derivatives

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Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

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The Greeks
Let V be the value of a portfolio of derivative securities based on one
underlying asset
The rates of change of the value V wrt pricing parameters (e.g., asset
price, volatility, etc.) useful for hedging
These rates of change are called the Greeks of the portfolio
Consider a portfolio containing a single European call option
Price using Black-Scholes
Inputs:

S
K
T
t

asset price
strike price
maturity
time

Kjell Konis (Copyright 2013)

r
q

asset volatility
(continuous) risk-free interest rate
(continuous) asset dividend rate

3. Partial Derivatives

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The Greeks
Black-Scholes formula for a European call option:
C (S, t) = Se q(T t) (d+ ) Ke r (T t) (d )
where
(z) =

2
log

d+ =

Z z

x2

e 2 dx

 
S
K

d = d+ T t =

Kjell Konis (Copyright 2013)

+ r q + 2

T t
log

(T t)

 

3. Partial Derivatives

S
K

+ r q 2

T t

(T t)

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Put-Call Parity

C (t) and P(t) prices of European call and put options on same asset
Same maturity T and strike price K
Put-Call parity states that
P(t) + S(t)e q(T t) C (t) = Ke r (T t)

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3. Partial Derivatives

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The Greeks

Delta (): rate of change of C wrt S

C
S

Gamma (): rate of change of wrt S

2C

=
S
S 2

Theta (): rate of change of C wrt t

C
t

Rho (): rate of change of C wrt r

C
r

vega =

Vega: rate of change of C wrt

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3. Partial Derivatives

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Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

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Delta
The Delta () of a European call option is the rate of change of
C (S, t) wrt the asset price S

C (S, t)
S

i
h q(T t)
Se
(d+ ) Ke r (T t) (d )
S

e q(T t)





S(d+ ) Ke r (T t)
(d )
S
S

By the product rule:


=

q(T t)

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(d+ ) Ke r (T t)
(d )
(d+ ) + S
S
S


3. Partial Derivatives

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Delta (continued)
Consider the partial derivatives


(d )
S
The chain rule says

 d


(d ) =
(d )
S
d
S

Recall definition of
Z d

(d ) =

(d ) =
d

Z d

(x ) dx =

x2
1
e 2 dx
2

Z d

(x ) dx =
d

Z d

x2
1
e 2 dx
2

(d )2

1
(d ) = (d ) = e 2
d
2
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3. Partial Derivatives

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Delta (continued)
Results so far



(d+ ) Ke r (T t)
=e
(d+ ) + S
(d )
S
S





d
(d ) =
(d )
S
d
S
q(T t)

(d )2

1
(d ) = (d ) = e 2
d
2

Substituting


= e q(T t) (d+ ) + S (d+ )

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d
d+
Ke r (T t) (d )
S
S

3. Partial Derivatives

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Delta (continued)
Finally, need to compute partial derivatives of d+ and d wrt to S
log

 

d =

d =
S
=

+ r q 2

T t

S
1
log
S
K
T t

d =
S
Let u =

S
K

S
K,

(T t)



r q 2 (T t)

+
S
T t

then by the chain rule


1
1 u
1
K 1
1

=
log(u) =
T t u S
T t S K
T t S

S T t

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3. Partial Derivatives

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Delta (continued)
Putting it all together . . .


= e q(T t) (d+ ) + S (d+ )

d =
S

d
d+
Ke r (T t) (d )
S
S


S T t

Yields the following expression for

= e q(T t) (d+ ) +

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e q(T t) (d+ ) Ke r (T t) (d )

T t
S T t
3. Partial Derivatives

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Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

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Gamma ()
Gamma () is the rate of change of Delta ()
Hence: Gamma () is the second partial derivative of C wrt S
=

C
2C
=
=
S
S S
S 2

So, all we have to do is . . .


"

e q(T t) (d+ ) Ke r (T t) (d )

=
=
e q(T t) (d+ ) +

S
S
T t
S T t

Luckily, there is a shortcut

Kjell Konis (Copyright 2013)

3. Partial Derivatives

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Simplifying the Expression for Delta


The textbook says
= e q(T t) (d+ ) +

e q(T t) (d+ ) Ke r (T t) (d )

T t
S T t

Finding an expression for much easier if


e q(T t) (d+ ) Ke r (T t) (d ) ?

=0
T t
S T t
Strategy: manipulate (d ) into (d+ ) and see what falls out
d2
1
(d ) = exp
2
2
Kjell Konis (Copyright 2013)

2 !
d+ T t
1
= exp
2
2

3. Partial Derivatives

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Simplifying the Expression for Delta


(d ) =

2 !
d+ T t
1
exp
2
2
!

2 2d T t + 2 (T t)
d+
1
+
exp
2
2
d2
1
exp +
2
2

!
!

2d+ T t
2 (T t)
exp
exp
2
2






= (d+ ) exp d+ T t exp 2 (T t)/2

log
Reminder: d+ =
"

 
S
K

S
= (d+ ) exp log
K
Kjell Konis (Copyright 2013)

+ r q + 2

T t


(T t)

2
+ r q+
2
3. Partial Derivatives

2 (T t)
(T t) exp
2
#

"

51 / 68

Simplifying the Expression for Delta


S
(d ) = (d+ ) exp
K
= (d+ )

"

2
r q+
2

2
(T t) (T t)
2

S r (T t) q(T t)
e
e
K

Substituting
e q(T t) (d+ ) Ke r (T t) (d )

T t
S T t
=

e q(T t) (d+ ) Ke r (T t) (d+ ) KS e r (T t) e q(T t)

T t
S T t

e q(T t) (d+ ) e q(T t) (d+ )

=0
T t
T t

Kjell Konis (Copyright 2013)

3. Partial Derivatives

52 / 68

Gamma ()

=
=
S
=

"

e q(T t) (d+ ) Ke r (T t) (d )

e q(T t) (d+ ) +
S
T t
S T t
i
h q(T t)
e
(d+ )
S

= e q(T t)



(d+ )
S

= e q(T t)

d+
(d+ )
d+
S

d
1

=
S
S T t

e q(T t)

(d+ )
S T t
2

d+

e q(T t)
1

e 2
=
S
S T t 2

Kjell Konis (Copyright 2013)

3. Partial Derivatives

53 / 68

Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

54 / 68

Rho ()
Rho () is the rate of change of the value of the portfolio wrt the
risk-free interest rate r
Black-Scholes formula
C (S, t) = Se q(T t) (d+ ) Ke r (T t) (d )
Derivative wrt r :
=

i
h q(T t)
Se
(d+ ) Ke r (T t) (d )
r

Product rule:
= Se q(T t)

(d+ )
r

K (T t)e
Kjell Konis (Copyright 2013)

r (T t)

(d ) + Ke

3. Partial Derivatives

r (T t)

(d )
r

55 / 68

Rho ()
Chain rule:
= Se q(T t) (d+ )

d+
r

K (T t)e r (T t) (d ) + Ke r (T t) (d )

d
r

Need partial derivatives of d+ and d wrt r :


log
d =

d =
r

 
S
K

+ r q 2

T t

(T t)

r T t
=
+C

T t

Kjell Konis (Copyright 2013)

3. Partial Derivatives

56 / 68

Rho ()
Substituting

r d

T t

...

= K (T t)e r (T t) (d )

T t
T t
q(T t)
r (T t)
+ Se
(d+ )
+ Ke
(d )

Rewrite as . . .
= K (T t)e r (T t) (d )
"

e q(T t) (d+ ) Ke r (T t) (d )

+ S(T t)
+
T t
S T t

= K (T t)e r (T t) (d )
Kjell Konis (Copyright 2013)

3. Partial Derivatives

57 / 68

Vega
Vega is the rate of change of the value of the portfolio wrt the
volatility
Black-Scholes formula
C (S, t) = Se q(T t) (d+ ) Ke r (T t) (d )
Derivative wrt :
vega =

i
h q(T t)
Se
(d+ ) Ke r (T t) (d )

Chain rule:
vega = Se q(T t) (d+ )
Kjell Konis (Copyright 2013)

d+
d
Ke r (T t) (d )

3. Partial Derivatives

58 / 68

Vega
Partial derivatives of d+ and d wrt :
 

+ r q 2

T t

log

 

+ (r q)(T t)
(T t)

T t
2 T t

S
K

d =

=
d

S
K

log

log

 

log

 

log

 

=
Kjell Konis (Copyright 2013)

S
K

S
K

S
K

(T t)

+ (r q)(T t)
(T t)

2
T t
2 T t

2
+ (r q)(T t)
(T t)
2

2
2
T t
T t
2

+ (r q 2 )(T t)

2 T t
3. Partial Derivatives

59 / 68

Bag of Tricks
Substitute
log

d =

 
S
K

+ (r q 2 )(T t)

2 T t

into
vega = Se q(T t) (d+ )

d+
d
Ke r (T t) (d )

Looks like its going to get worse before it gets better


Another approach . . .
Already have
e q(T t) (d+ ) Ke r (T t) (d )

=0
T t
S T t
Rewrite as
Se q(T t) (d+ ) = Ke r (T t) (d )
Kjell Konis (Copyright 2013)

3. Partial Derivatives

60 / 68

Vega
The expression for vega becomes
d
d+
Ke r (T t) (d )
vega = Se q(T t) (d+ )

d+ d

= Se q(T t) (d+ )

= Se q(T t) (d+ )

(d+ d )

Recall: d = d+ T t so that

d+ d = d+ (d+ T t)

T t

=
T t

(d+ d ) =

Kjell Konis (Copyright 2013)

3. Partial Derivatives

61 / 68

Vega
Substuting . . .
vega = Se q(T t) (d+ )

vega = S

(d+ d )

T t e q(T t) (d+ )

Kjell Konis (Copyright 2013)

3. Partial Derivatives

62 / 68

Outline
1

Functions of Several Variables

Higher Order Partial Derivatives

Functions of Two Variables

The Chain Rule for Functions of Several Variables

Implicit Functions

Put-Call Parity and The Greeks

Delta

Gamma ()

Rho () and Vega

10

Theta ()
Kjell Konis (Copyright 2013)

3. Partial Derivatives

63 / 68

Theta ()
Theta is the rate of change of the value of the portfolio wrt the time t
Black-Scholes formula
C (S, t) = Se q(T t) (d+ ) Ke r (T t) (d )
Derivative wrt t:
=

i
h q(T t)
Se
(d+ ) Ke r (T t) (d )
t

Product rule twice:


= qSe q(T t) (d+ ) + Se q(T t)

(d+ )
t

rKe r (T t) (d ) + Ke r (T t)
Kjell Konis (Copyright 2013)

3. Partial Derivatives

(d )
t

64 / 68

Theta ()
= qSe q(T t) (d+ ) rKe r (T t) (d )


+ Se q(T t)

(d+ ) Ke r (T t) (d )
t
t

= qSe q(T t) (d+ ) rKe r (T t) (d )




+ Se q(T t) (d+ )

d+
d
Ke r (T t) (d )
t
t

= qSe q(T t) (d+ ) rKe r (T t) (d )


+ Se q(T t) (d+ )
Kjell Konis (Copyright 2013)

d+ d

t
t

3. Partial Derivatives

65 / 68

Theta ()
Again, rewrite the quantity


d+ d

t
t

(d+ d )
t


T t
t

2 T t

(T t) 2
t

Substitute into . . .
= qSe q(T t) (d+ ) rKe r (T t) (d )
+ Se q(T t) (d+ )
Kjell Konis (Copyright 2013)

d+ d

t
t

3. Partial Derivatives

66 / 68

Theta ()
Finally . . .

Se q(T t)

(d+ ) + qSe q(T t) (d+ ) rKe r (T t) (d )


2 T t

Kjell Konis (Copyright 2013)

3. Partial Derivatives

67 / 68

http://computational-finance.uw.edu

Kjell Konis (Copyright 2013)

3. Partial Derivatives

68 / 68

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