Binomial Option Pricing Under Stochastic Volatility and Correlated State Variables

Posted: 15 Mar 1995

See all articles by Jimmy E. Hilliard

Jimmy E. Hilliard

Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration

Adam Schwartz

Washington and Lee University - Department of Business Administration

Multiple version iconThere are 2 versions of this paper

Date Written: October, 1994

Abstract

Univariate procedures for valuing contingent payoffs for a non-constant volatility process via a recombining tree were developed by Nelson and Ramaswamy (RFS, 1990). Their results have been extended to the bivariate case for a subset of diffusions by, among others, Kishimoto (JF, 1989), Boyle, Evnine and Gibbs (RFS, 1989), and Hull and White (JFQA,1990). The case of correlated diffusions with constant correlations has also been addressed by Hull and White (JFQA,1990), Amin (JFQA,1991) and Wei(JFEng, 1993). This paper investigates the case where the diffusion volatility includes the state variable from a second diffusion. The direct application of the technology provides a way to price, for example, derivatives based on processes with stochastic volatility via a simple recombining binomial tree with a set of four joint, but possibly non-independent probabilities.

JEL Classification: 521

Suggested Citation

Hilliard, Jimmy E. and Schwartz, Adam, Binomial Option Pricing Under Stochastic Volatility and Correlated State Variables (October, 1994 ). Available at SSRN: https://ssrn.com/abstract=5973

Jimmy E. Hilliard (Contact Author)

Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration ( email )

Department of Finance
Baton Rouge, LA 70803-6308
United States
225-578-7676 (Phone)
225-578-6366 (Fax)

Adam Schwartz

Washington and Lee University - Department of Business Administration ( email )

Lexington, VA 24450
United States

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