 Solution

Take bank-account values $B_k=R^k$ with $R>0$, and let the stock multiply independently by $u$ or $d$ at each step, where $0<d<R<u$. Under the physical probability measure $P$, the up probability is $p\in (0,1)$; the filtration records the successive moves. These assumptions specify the standard binomial market. If $R$ lies outside the strict interval $(d,u)$, a long or short stock position financed through the bank account gives an arbitrage.

The risk-neutral probability in a binomial market is fixed by $qu+(1-q)d=R$, givingFor successor claim values $V_u,V_d$ at a node with current stock price $S$, solve the two replication equations. The current stock holding and current cash value areThe cost of this replicating portfolio in a binomial market isApply this backward option pricing recursion from any terminal contingent claim $H$, including claims depending on the whole sequence of moves. It constructs a self-financing portfolio and proves market completeness by induction on the remaining number of periods. Taking successive conditional expectations under the measure $Q$ with independent up probability $q$ gives the unique risk-neutral pricing valueAny other price would give an arbitrage by buying the cheaper of the claim and its replica and selling the dearer.

If $K$ is the number of up moves, a particular path has probabilities $p^K(1-p{)}^{n-K}$ under $P$ and $q^K(1-q{)}^{n-K}$ under $Q$. Therefore the binomial-market probability density, namely the Radon-Nikodym derivative, isThis last expression makes $Z$ a function of the terminal stock price. Summing over paths gives ${\mathbb{E}}_{P}Z=1$, and strict positivity proves equivalence of the two probability measures.

For unrestricted terminal portfolio wealth $H$, its initial replication cost is $R^{-n}{\mathbb{E}}_{Q}H$. Hence feasible wealth satisfies the state-price budget constraint ${\mathbb{E}}_{Q}H=R^n{w}_0$. For the stated exponential utility, $v^{\prime }(x)=e^{-ax}$ and $v^{\prime \prime }(x)=-a{e}^{-ax}<0$. The binomial exponential-utility terminal wealth iswhereIt satisfies the budget, and its marginal utility is $v^{\prime }(H^{\ast })=\lambda Z$ with $\lambda =\exp (-a{R}^n{w}_0-{\mathbb{E}}_Q\log Z)>0$. The concave supporting-tangent inequality givesTaking expectations under $P$ makes the last term zero by the budget. Strict concavity makes equality possible only when $H=H^{\ast }$ in every positive-probability state. The already constructed complete market supplies its replicating strategy, so this proves global optimality and uniqueness. The formula allows negative final wealth, as permitted by the unrestricted trading problem.