The Rate of Convergence of Binomial Lattice Models for Pricing Vanilla Options
28 Pages Posted: 17 Jun 2013 Last revised: 15 Sep 2014
Date Written: November 25, 2011
Variations of the binomial tree model are reviewed and extensions to the two most efficient trees studied in a recent literature are proposed. Tian’s modified tree is extended to a more general class of tree, and the third order tree is extended to the seventh order tree. Analysis of the error of American put pricing in the binomial tree model is presented and new trees that have superior performance in pricing in-the-money American puts are developed. To further improve numerical results, a scheme that incorporates different trees is suggested.
Keywords: American put option, rate of convergence, binomial trees
JEL Classification: G13
Suggested Citation: Suggested Citation