Hi, would someone mind explaining these two concepts? The way the official guide shows them is not clear to me.
Why does option valuation relies on these two concepts?
"The two-period binomial option valuation model illustrates two important concepts, self-financing and dynamic replication.
- Self-financing implies that the replicating portfolio will not require any additional funds from the arbitrageur during the life of this dynamically rebalanced portfolio. If additional funds are needed, then they are financed externally.
- Dynamic replication means that the payoffs from the option can be exactly replicated through a planned trading strategy.
Option valuation relies on self-financing, dynamic replication"