Lean Trees - a General Approach for Improving Performance of Lattice Models for Option Pricing

17 Pages Posted: 18 Jan 2001

See all articles by Rainer Baule

Rainer Baule

University of Hagen

Marco Wilkens

University of Augsburg

Multiple version iconThere are 2 versions of this paper

Date Written: January 24, 2001

Abstract

The well-known binomial and trinomial tree models for option pricing are examined from the point of view of numerical efficiency. Common lattices use a large part of time resources for calculations which are almost irrelevant for the solution. To avoid this waste of resources, the tree is reduced to a "lean" form which yields the same order of convergence, but with a reduction of numerical effort to O(n^(3/2) log n) (where n is the number of time steps). Two instances of this Lean Tree Model are presented: a binomial one for pricing American put options and a trinomial one with largest possible generality to be used for a wide class of derivatives. In numerical tests it is shown that the proposed method leads to a significant improvement in real calculation time without loss of accuracy.

Keywords: Lean Trees, Lattice Models, Option Pricing, Numerical Valuation Techniques

JEL Classification: G13, C63

Suggested Citation

Baule, Rainer and Wilkens, Marco, Lean Trees - a General Approach for Improving Performance of Lattice Models for Option Pricing (January 24, 2001). Available at SSRN: https://ssrn.com/abstract=256718 or http://dx.doi.org/10.2139/ssrn.256718

Rainer Baule (Contact Author)

University of Hagen ( email )

Universitaetsstrasse 41
Hagen, 58097
Germany

Marco Wilkens

University of Augsburg ( email )

Universitaetsstr. 16
Augsburg, 86159
Germany
+49 821 598 4124 (Phone)
+49 821 598 4223 (Fax)

HOME PAGE: http://www.wiwi.uni-augsburg.de/bwl/wilkens/team/wilkens_marco/

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