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Anda di halaman 1dari 14

Martin Herdegen

24 March 2009

1

1.1

Introduction

The market model

B and a stock S whose dynamics under the unique risk-neutral measure P are

given by

dB(t) = rB(t) dt

dS(t) = rS(t) dt + S(t) dW (t)

(1)

B(0) = 1

S(0) = x

where r, are deterministic constants with > 0 and W (t) is a Brownian

motion under P. We refer to r as the interest rate and to as the volatility of

S. We denote by {Ft }t0 the natural augmented filtration of W . It is easy to

verify that (1) under P has the unique strong solution

B(t) = ert

(2)

/2)t

(3)

1.2

Pricing formula

Theorem 1 (Fundamental theorem of asset pricing). Let T > 0 and D be a Pintegrable and FT -measurable random variable, which we interpret as the value

of some derivative security at time T . The arbitrage-free price of D at time

t [0; T ] is given by

D(t) = E[er(T t) D|Ft ]

(4)

Moreover ert D(t) is a {Ft }-martingale under P.

Proof. See [8] Chapter 5.

1.3

price K > 0 and time of maturity T > 0 on the underlying asset S is a

contract defined as follows

The holder of the option has, exactly at time T [at any time t [0; T ]],

the right but not the obligation to buy one share of the underlying asset S

at price K from the underwriter of the option.

Definition 2. A European [American] put option P Eur [P Am ] with strike

price K > 0 and time of maturity T > 0 on the underlying asset S is a

contract defined as follows

The holder of the option has, exactly at time T [at any time t [0; T ]],

the right but not the obligation to sell one share of the underlying asset S

at price K to the underwriter of the option.

We fix a strike K > 0 and a time of maturity T > 0. By theorem 1, the

arbitrage-free prices of a European call [put] at time 0 is given by

C Eur = E[erT (S(T ) K)+ ]

P

Eur

= E[e

rT

(K S(T )) ]

(5)

(6)

Now suppose we are the owner of an American call [put] option. Since we can

exercise the option at any time t [0; T ], we choose an {Ft }-stopping time

[0, T ] taking values in [0, T ]. At time T we own er(T ) (K S( ))2 . Since

we may choose any {Ft }-stopping time [0, T ], theorem 1 implies3 that the

arbitrage-free price of an American call [put] option at time 0 is given by

C Am = sup E[er (S( ) K)+ ]

(7)

[0,T ]

(8)

[0,T ]

exercise strategy = T . The following theorem states in which cases the latter

strategy is indeed the best that we can do.

Theorem 2.

1. Suppose r 0. Then C Am = C Eur .

2. Suppose r = 0. Then P Am = P Eur .

Proof.

1 See

we exercise before time T , we invest our money for the rest of the time up to T in the

risk-less bond

3 More precisely this follows once we have shown the existence of an optimal stopping time.

2 If

is convex. Jensens inequality for conditional expectations, the fact that

ert S(t) is a martingale and the optional sampling theorem yield

C Eur = E[erT (S(T ) K)+ ] = E[g1 (erT S(T ))]

= E[E[g1 (erT S(T ))|F ]] E[g1 (E[erT S(T )|F ])]

= E[g1 (er S( ))] = E[(er S( ) erT K)+ ]

E[er (S( ) K)+ ]

(9)

C Eur C Am yields the claim.

2. Fix [0, T ]. Define g2 : R+ R+ by g2 (x) = (K x)+ . Clearly g2

is convex. Jensens inequality for conditional expectations, the fact that

S(t) is a martingale and the optional sampling theorem yield

C Eur = E[(K S(T ))+ ] = E[g2 (S(T ))]

= E[E[g2 (S(T ))|F ]] E[g2 (E[S(T )|F ])]

= E[g2 (S( ))] = E[(K S( ))+ ]

(10)

P Eur P Am yields the claim.

Remark. If r > 0 the above argument breaks down for the American put. We

will show below that in this case we have P Am > P Eur and we will derive an

explicit formula for difference P Am P Eur .

2

2.1

Formal definition of the problem

F , Fs , P},

Let {W

(0, ) (Perpetual American Put) or E = [0, T ] (0, ); 0 < T < (Finite

F = B(E) F and G = {, E} F . For

American Put). Set = E ,

s 0 and = (t, x,

) define

(s)(

W (s)() = W

)

S(s)() = xeW (s)()+(r

/2)s

(11)

X(s)() = (t + s, S(s)())

where r, are deterministic constants with , r > 0. Moreover, for s 0,

let Fs = B(E) Fs and Gs = {, E} Fs . Finally define probability mea and

sures {P(t,x) }(t,x)E on {, F } and P on {, G } by P(t,x) := t x P

defined by () = 0; (E) = 1. For convenience we set Px := P(0,x) . It is not

difficult to check that {W (s)}s0 is a Brownian motion on {, G , Gs , P} and

{S(s)}s0 and {X(s)}s0 are strong Markov families on {, F , Fs , {Px }x>0 }

and {, F , Fs , {P(t,x) }(t,x)E }.

3

Remark. Under P(t,x) we interpret S(s) as the value of a stock S with volatility

= x.

in a financial market with interest rate r at time t + s given that S(t)

We fix a strike price K > 0. Define the gain function G : E 7 [0, K] by

G(t, x) := ert (K x)+ . For (t, x) E define the optimal stopping problem

V (t, x) =

sup

E(t,x) [G(X(s))]

[0,T t]

sup

(12)

[0,T t]

is a stopping time4 taking values in [0, T t]5 . Since G is bounded, V (t, x) is

defined for all (t, x) E. We call V the value function.

Remark. We interpret V (t, x) as the arbitrage free price of an American put

= x. Since

option with strike K and maturity T on S at time 0 given that S(t)

we have a positive interest rate r, we cannot compare prices at different times

directly, but need to discount appropriately. The price of an American put

= x is given by

option at time t given S(t)

v(t, x) = ert V (t, x) =

sup

Ex [er (K S( ))+ ]

(13)

[0,T t]

g(t, x) = ert G(t, x) = (K x)+

(14)

which we call the gain* function. Even though V and G are the formal correct

objects, which in addition carry the economic interpretation of time value of

money, it turns out that v and g are the convenient mathematical objects to

work with.

2.2

Lemma 1.

1. If T = , the function t 7 v(t, x) is constant

2. If T < , the function t 7 v(t, x) is decreasing with v(T, x) = (K x)+ .

Proof. Let 0 t1 t2 T 6 . Then

v(t1 , x) =

sup

Ex [er (K S( ))+ ]

[0,T t1 ]

sup

Ex [er (K S( ))+ ]

(15)

[0,T t2 ]

= v(t2 , x)

Since [0, t1 ] = [0, t2 ] and clearly v(T, x) = (K x)+ by definition for

T < , both assertions follow immediately.

4 In general we allow to be an {F }-stopping time. Note, however, that for fixed

t

(t, x) E for each {Ft }-stopping time F there exists a {Gt }-stopping time G with

F = G P(t,x) -a.s.. If necessary we will work with G rather than with F , which will

always be clear from the context.

5 t := ; moreover we allow = if T =

6 We require t <

Proof. Fix t [0, T ]7 . For [0, T t], x > 0 define

u(x, ) := er (K xeW ( )+(r

/2) +

(16)

integral it follows that x 7 E[u(x, )] is convex. Moreover clearly

v(x, t) =

sup

E[u(x, )]

(17)

[0,T t]

The assertion follows by the well-know facts that the supremum of convex functions is convex again, and that convex functions are continuous.

Lemma 3. The function (t, x) 7 v(t, x) is lsc.

Proof. For [0, T ] and (t, x) E define

u(t, x, ) := er( (T t)) (K xeW ( (T t))+(r

/2)( (T t)) +

(18)

convergence theorem we get that (t, x) 7 E[u(t, x, ))] is continuous. Moreover

clearly8

v(x, t) = sup E[u(t, x, )]

(19)

[0,T ]

The assertion follows by the well-know fact that the supremum of lsc functions

is lsc again.

2.3

the continuation set

C := {(t, x) [0, T ) (0, ) : V (t, x) > G(t, x)}

= {(t, x) [0, T ) (0, ) : v(t, x) > g(x)}

(20)

D := {(t, x) [0, T ] (0, ) : V (t, x) = G(t, x)}

= {(t, x) [0, T ] (0, ) : v(t, x) = g(x)}

(21)

we define the stopping time9

D := inf{s 0 : Xs D}

(22)

Lemma 4. All points (t, x) [0, T ) [K, ) belong to the continuation set C.

7 Again

we require t <

{ (T t) : [0, T ]} = { : [0, T t]}

9 This is indeed a stopping time since D is closed and X is continuous.

8 Note

Proof. Let (t, x) [0, T ) [K, ) and 0 < < K. Define the stopping time10

:= inf{s 0 : Ss K } (T t)

(23)

It is not difficult to show that P(t,x) (0 < < T t) =: > 0. Hence we have

V (t, x) erT > 0 = G(t, x), which establishes the claim.

Now define w(t, x) = v(x, t) + x. Lemma 4 implies

C = {(t, x) [0, T ) (0, ) : w(t, x) > K}

(24)

(25)

limx0 w(t, x) = K.

Proof. Convexity follows from convexity of x 7 v(t, x) and x 7 x. The obvious

inequality (K x)+ + x w(t, x) K + x, implies K w(t, x) x (0, )

as well as limx0 w(t, x) = K. These two facts together with convexity of x 7

w(t, x) imply immediately that x 7 w(t, x) is increasing.

Lemma 4 and 5 imply that there exist a function b : [0, T ) [0, K) such that

2.3.1

(26)

(27)

For convenience set v(x) := v(0, x). For 0 < b < K define the stopping time

b = inf{s 0 : S(s) b} and let

vb (x) := Ex [erb (K S(b ))+ ]

(28)

The formula for the Laplace transform for the first passage time of a Brownian

motion with drift11 yields after some simple calculations

(

K x

if 0 < x b

2

(29)

vb (x) =

x 2r/

if x b

(K b) b

Define v (x) = supb(0,K) vb (x). Elementary Calculus yields

(

K x

if 0 < x b

2

v (x) = vb (x) =

2r/

(K b ) bx

if x b

(30)

2r

C 1 ((0, )) and

where b = 2r+

2 K. It is straightforward to check that v

2

v C ((0, b) (b, )) with

(

1

if 0 < x b

vx (x) = 2r

(31)

2 x v (x) if x b

(

0

if 0 < x < b

(32)

v (x) if x > b

4 x2

10 This

11 See

for instance [8] p 346 et seq (Theorem 8.3.2)

time for the Perpetual American Put.

Proof. Since V C 1,1 (E) C 1,2 (E\([0, ) b)) and Px (S(t) = b ) = 0 for

all x (0, ) and all t > 0, we can apply a slightly generalized version of Itos

formula12 to V (t, S(t)) and get

dV (t, S(t)) = rV (t, S(t)) dt + Vx (t, S(t)) dS(t)

1

+ Vxx

(t, S(t))1{S(t)6=b} dhS(t), S(t)i

2

= ert rK1{S(t)<b } dt + S(t)Vx (t, S(t)) dW (t)

(33)

Hence V (t, S(t)) is a {Ft }-supermartingale13 with V (t, S(t)) G(t, S(t))14 .

Let [0, ] be a stopping time. Monotonicity of the integral and the optional

sampling theorem yield

Ex [G(, S( ))] Ex [V (, S( ))] V (0, x) = v (x)

(34)

Taking the supremum in (34) over [0, ] yields v (x) v(x). On the other

hand v (x) v(x) by definition. Hence

v (x) = v(x) = Ex [v (b , S(b ))]

(35)

q.e.d.

2.3.2

Pt,x (D < ) = 1 by the main existence theorem of the Markovian approach

(Theorem 3.7 of the lecture notes).

2.4

Proof. Let 0 t1 < t2 < T . By Lemma 1 and the definitions of the functions

v, g and b we have

g(b(t1 )) = v(t1 , b(t1 )) v(t2 , b(t1 )) g(b(t1 ))

(36)

Then by Theorem 3

v(0, x) sup Ex [er (K S( ))+ ] = K x = g(x)

(37)

[0,]

b(t) < K.

12 confer

[6] p 74 et seq

rs 1.

S(s)V

x (s, S(s)) dW (s) is a proper martingale since |Vx (s, S(s))| e

0

14 Note that v (x) (K x)+ for x (0, ).

13

Rt

2.5

x (0, K]. Moreover limx0 v(t, x) = K and limx v(t, x) = 0.

Proof. The claim is trivial for t = T , so assume t < T . Lemma 5 implies

limx0 v(t, x) = limx0 w(t, x) = K. Moreover by (32) for x K

v(x, t) =

sup

Ex [er (K S( ))+ ]

[0,T t]

[0,]

= (K b )

x 2r/2

(38)

x 7 v(t, x) is convex by Lemma 2, x 7 v(t, x) is decreasing. Moreover clearly

v(t, x) > 0 for x < K. Again convexity of x 7 v(t, x) implies that x 7 v(t, x)

is strictly decreasing for x (0, K].

Lemma 8. The function v is continuous in E.

Proof. For t 0 define M (t) := sup0st |W (s)|. Fix x (0, ) and let

0 t1 < t2 T . Denote by 1 the {Gs }-optimal stopping time for v(t1 , x)

and define 2 := 1 (T t2 ). Clearly 1 2 with 1 2 t2 t1 . By

stationary and independent increments {W (2 + t) W (2 )}t0 is independent

of G2 and equal in law to {W (t)}t0 . Recalling that ert S(t) is a martingale

and v(t1 , x) v(t2 , x) we get

0 v(t1 , x) v(t2 , x)

Ex [er1 (K S(1 ))+ ] Ex [er2 (K S(2 ))+ ]

Ex [er2 [(K S(1 ))+ (K S(2 ))+ ]]

Ex [er2 (S(2 ) S(1 ))+ ]

Ex [er2 S(2 )(1 e(W (1 )W (2 ))+(r

/2)(1 2 ) +

E[e

r2

) ]

/2)(1 2 ) +

) |G2 ]]

W (1 2 )+(r /2)(1 2 ) +

S(2 )E[(1 e

) ]]

/2)|(t2 t1 ) +

) ]

(39)

2

dominated convergence h is continuous at 0 with h(0) = 0. Now fix (t0 , x0 ) E

and let {(tn , xn )}n1 be a sequence in E with limn (tn , xn ) = (t0 , x0 ). Then

by Lemma 2 and (39) we have

lim sup |v(tn , xn ) v(t0 , x0 )| lim sup |v(tn , xn ) v(t0 , xn )|

n

n

n

Hence v is continuous in E.

8

(40)

as well as vxx (t, x) 2r

2 x2 v(x, t).

Proof. Denote by LX the infinitesimal generator of X. It is not difficult to

establish that

2 2 2

LX =

(41)

+ rx

+

x

t

x

2

x2

Now fix (t0 , x0 ) C and let r0 > 0 such that B := B r0 (t0 , x0 ) C. Now

consider the following PDE

LX U = 0

U =V

in B

on B

(42)

exist a unique solution U of (42) in C 1,2 (B) C 0 (B). Let (t, x) B and > 0

be arbitrary. Since B is compact and U, V C 0 (B) with U = V on B there

exists 0 < r1 < r0 such that (t, x) B := Br (t0 , x0 ) and |U V | on B .

Let U : E 7 R be a C 1,2 -extension of U |B 16 . Now applying Itos formula to

U (Xs ) yields

dU (Xs ) = LX U (Xs ) ds + S(s)Ux (Xs ) dW (s)

(43)

Bc := inf{s 0 : Xs Bc }

(44)

Note that LX = 0 in B by (42). Hence (43) and the Optional Sampling theorem

yield17

U (t, x) = U (t, x) = E(t,x) [U (XBc )] = E(t,x) [U (XBc )]

(45)

On the other hand, since Bc D we get by the Strong Markov property

E(t,x) [V (XBc )] = E(t,x) [EXBc [G(XD )]]

= E(t,x) [G(XBc +D )] = E(t,x) [G(XD )]

= V (t, x)

(46)

|V (t, x) U (t, x)| = |E(t,x) [V (XBc ) U (XBc )]|

E(t,x) [|V (XBc ) U (XBc )|]

E(t,x) [ ] =

(47)

Since > 0 was arbitrary, we get V (t, x) = U (t, x). Thus V = U in B, which

in particular implies that V is C 1,2 in (t0 , x0 ). Since (t0 , x0 ) C was chosen

15 See

precisely U C 1,2 (E) and U = U on B .

R

17 Note that a priory we only know that t S(s)U (X ) dW (s) is local martingale. Theres

x

0

fore we use a localizing sequence {n }n0 of stopping times and observe that Ux is bounded

on B . The dominated convergence theorem then yields the desired result.

16 More

1 and Lemma 7 we get that vx 0 and vt 0. Moreover, an easy calculation

using LX V = 0 in C yields

vxx (t, x) =

2

2 x2

2r

v(t, x)

2 x2

(48)

Proof. Fix t [0, T ). Since x 7 v(t , x) is convex by Lemma 2, the right-hand

+

derivative xv (t , x) exist for all x (0, ). Denote x = b(t ) < K. Then

+v

v(t , x + ) v(t , x )

(t , x ) = lim

0

x

g(x + ) g(x )

= 1

lim

0

(49)

stopping time for v(t , x + ) for 0. Since b is increasing by lemma 6,

clearly x under P(t ,x +) for all 0. Moreover by (29) we have

0

0

= lim

0

x +

x

2r/2

=1

(50)

This implies that for any sequence {n }n1 in R+ with limn n = 0 we have

limn n = 0 in probability. For t 0 define M (t) := sup0st |W (s)| and

2

2

for convenience set (t) := eW (t)+(r /2)t and (t) := e M (t)|(r /2)|t .

Let > 0 be arbitrary and {n }n1 a sequence in R+ with limn n = 0.

After possibly discarding a subsequence we may assume that limn n = 0

a.s. Then it holds

v(t , x + n ) v(t , x )

+v

(t , x ) = lim sup

x

n

n

lim sup E[er

n

r

n

(51)

+v

(t , x ) 1

x

18 Clearly

10

(52)

+v

x (t , x )

= 1. Finally we have

v

v(t , x ) v(t , x )

(t , x ) = lim

0

x

g(x ) g(x )

= 1

= lim

0

(53)

Lemma 11. The function x 7 v(t, x) is C 1 with 1 vx (t, x) 0.

Proof. Fix t [0, T ). For x > b(t ) the assertion follows by lemma 7; for

x < b(t ) this follows by the fact that v(t, x) = g(x) in (0, b(t )] and clearly

g(x) C 1 ((0, b(t )]). Now let x = b(t ). Since x 7 v(t , x) is differentiable at

b(t ) by lemma 10 with vx (t , b(t )) = 1 = limxb(t ) vx (t , x), it remains to

show that

lim vx (t , x) = 1

(54)

xb(t )

vx (t , x) =

+v

(t , x)

x

(55)

This fact together with (55) immediately establishes (54). Hence x 7 v(t , x) is

C 1 . Finally, clearly vx (t , x) = 1 for x (0, b(t )] and hence by continuity of

x 7 vx (t , x), convexity of x 7 v(t , x) and lemma 9 we get 1 vx (t , x) 0

for x (0, b(t )].

2.6

Proof.

Right-continuity: Let t [0, T ). Since b is increasing by Lemma 6, the

right-hand limit b(t+) exists with b(t) b(t+) < K. Moreover by definition (t, b(t)) D for t [0, T ). Since D is closed, it follows that

(t, b(t+)) D. This together with Lemma 7 implies

0 v(t, b(t+)) v(t, b(t))

= (K b(t+)) (K b(t))

= b(t) b(t+) 0

(56)

Left-continuity: Let t (0, T ]. For convenience set b(T ) := K. Since b

is increasing, the left-hand limit b(t) exists with b(t) b(t) K 20 .

Moreover (t, b(t)) D for t [0, T ). Since D is closed, it follows that

19 For

that b(t) < K for t [0, T ).

20 Recall

11

(t, b(t)) D. Seeking a contradiction, suppose that b(t) < b(t). Set

x := (b(t) + b(t))/2 and let t0 < t21 . Then

b(t0 ) b(t) < x < b(t) K

(57)

definition of C and Lemma 10 we have

v(t0 , b(t0 )) g(b(t0 ) = 0

vx (t0 , b(t0 )) gx (b(t0 ) = 0

(58)

2r

2r

v(t0 , x) 2 2 (K x)

2 x2

x

2r

2 0 2 (K x ) =: > 0

b(t )

vxx (t0 , x)

(59)

with (58) yields

0

v(t , x ) g(x ) =

b(t0 )

=

b(t0 )

b(t0 )

dz dy =

b(t0 )

b(t0 )

(x b(t0 ))2

2

(60)

v(t, x ) g(x )

(x b(t))2

>0

2

(61)

Hence (t, x )

/ D in contradiction to (t, x ) D. Thus b(t) = b(t) and

t 7 b(t) is left-continuous with limtT b(t) = K.

Lemma 13. The function t 7 b(t) is convex and satisfies

log(b(t)/K)

lim p

=1

tT (T t)( log(8r 2 (T t)/ 2 ))

(62)

Remark. This result will not be used in the following.

2.7

The above lemmata imply22 that V C 0,1 (E\{T } {K}) C 1,2 (E\(b(t)))23 .

Moreover, since P(t,x) (X(s) = b(t + s)) = 0 for all (t, x) (0, T ) (0, ) and

that t0 < T .

that clearly V C 1,2 (Int{D}).

23 (b(t)) := {(t, x) [0, T ] (0, ) : x = b(t)}

21 Note

22 Note

12

all 0 < s < T t, we can apply a slightly generalized version of Itos formula24

to V (Xs ) and get

dV (Xs ) = LX V (Xs )1{X(s)6=b(t+s)} ds + Vx (X(s)) dS(t)

= ers rK1{S(s)<b(t+s)} dt + S(t)Vx (Xs ) dW (t)

(63)

Z T t

E(t,x) [V (X(T t))] = V (t, x)rK

er(t+s) P(t,x) (S(s) < b(t+s)) ds (64)

0

E(t,x) [V (X(T t))] = E(t,x) [EX(T t) [G(X(D ))]]

= E(t,x) [E(t,x) [G(X((T t) + D ))|FT t ]]

= E(t,x) [G(X((T t) + D ))]

= E(t,x) [G(X((T t)))]

(65)

v(t, x) = er(T t) E(t,x) [g(S(T t))]

Z T t

+ rK

ers P(t,x) (S(s) < b(t + s)) ds

(66)

V (0, x) = Ex [erT (K S(T ))+ ]

Z T

b(s)

2

1

rs

log

r

s

ds

+ rK

e

b(0)

2

s

0

(67)

Remark. Formula (67) is called the early exercise premium representation of

the value function. It shows that the value of an American put option with strike

price K and maturity T is the sum of the value of an European put option with

the same strike and maturity and the so-called early exercise premium.

2.8

Theorem 4. The function t 7 b(t) is the unique solution in the class of continuous increasing functions c : [0, T ] R satisfying 0 < c(t) < K for all

0 < t < of the following free-boundary integral equation

Z K

1

K x

2

K b(t) = er(T t)

log

r

(T t)

dx

b(t)

2

T t

0

Z T t

1

b(t + s)

2

rs

+ rK

e

log

r

s

ds (68)

b(t)

2

s

0

24 confer

25 Note

ert < 1.

[6] p 74 et seq

R

that 0t S(s)Vx (s, S(s)) dW (s) is a proper zero-mean martingale since |Vx (Xs )|

13

Proof.

t 7 b(t) is a solution of (68): Plugging (t, b(t)) in (66) and noting that

v(t, b(t)) = K b(t) yields after some lengthy calculation (68).

t 7 b(t) is the unique solution of (68): See [6] p 386 - 392.

References

[1] Thomas Bj

ork, Arbitrage theory in continuous time, 2nd ed., Oxford University Press, 2004.

[2] Xinfu Chen, John Chadam, Lishang Jiang, and Weian Zheng, Convexity of

the exercise boundary of the american put option on a zero dividend asset,

Mathematical Finance 18 (2008), 185 197.

[3] Laurence Evans, Partial differential equations, Oxford University Press,

1998.

[4] Ioannis Karatzas and Steven Shreve, Brownian motion and stochastic calculus, 2nd ed., Springer-Verlag, 1991.

[5] Achim Klenke, Wahrscheinlichkeitstheorie, Springer-Verlag, 2006.

[6] Goran Peskir and Albert Shiryaev, Optimal stopping and free-boundary problems, Birkh

auser Verlag, 2006.

[7] Daniel Revuz and Mark Yor, Continuous martingales and brownian motion,

3rd ed., Springer-Verlag, 2005.

[8] Steven Shreve, Stochastic calculus for finance 2, 2nd ed., Springer-Verlag,

2004.

14

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