Option Pricing Trees
JOURNAL OF DERIVATIVES Vol 2 No 4
Posted: 10 Oct 1998
Abstract
This article provides a selective description of numerical techniques for option valuation when the underlying model is based on certain kinds of diffusion processes. It emphasizes models based on discretizing the underlying process on a finite state space at discrete points in time and describes techniques for building both path-dependent and path-independent discrete-time models that can approximate a given continuous-time process for the underlying state variables. Monte Carlo methods or numerical methods for solving partial differential equations are almost completely ignored.In the interest of clarity, the focus is on specific processes to illustrate the basic principles, forgoing technical details that may cloud the basic concepts. The major focus is on describing models that can be realistically implemented in practice.
JEL Classification: G13
Suggested Citation: Suggested Citation