The Convergence Speed of Pricing European-Style Derivatives under Lattice Models

29 Pages Posted: 27 Jun 2015

See all articles by Wen-Kai Wang

Wen-Kai Wang

National University of Kaohsiung - Department of Finance

Date Written: June 24, 2015

Abstract

It is known that the Black-Scholes model can be well approximated by lattice models such as the Cox-Ross-Rubinstein (CRR) model in Cox, Ross, and Rubinstein (1979). The orders of convergence of several lattice models have been shown in Leisen and Reimer (1996). In this study, we consider a derivative pricing problem where the value of the underlying asset follows a more general stochastic process instead of a geometric Brownian motion (GBM). In addition, we do not focus on only European call options. Instead, a more general European-style derivative is allowed. We provide a different proof from the one in Leisen and Reimer (1996) and show that the order of convergence of lattice approximation used to price European-style derivatives is 1.

Keywords: Lattice model, Derivative pricing

JEL Classification: G13, Q20, Q22

Suggested Citation

Wang, Wen-Kai, The Convergence Speed of Pricing European-Style Derivatives under Lattice Models (June 24, 2015). Available at SSRN: https://ssrn.com/abstract=2622835 or http://dx.doi.org/10.2139/ssrn.2622835

Wen-Kai Wang (Contact Author)

National University of Kaohsiung - Department of Finance ( email )

700 Kaohsiung University Rd.
Nanzih District
Kaohsiung 803
Taiwan

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