On Pricing Barrier Options
THE J. OF DERIVATIVES, Vol. 3 No. 2, Winter 1995
Posted: 13 Jul 1998
Pricing and hedging barrier options using a binomial lattice can be quite delicate. If the barrier is not constant, or if there are multiple barriers, then in all likelihood binomial lattices will produce erroneous answers even when a large number of time steps are used. While in some cases the time partitions of the binomial method can be carefully chosen so as to reduce the bias, for many barrier contracts more efficient procedures exist.This article explains how a very simple and extremely efficient trinomial lattice procedure can be used to price and hedge most types of exotic barriers.
JEL Classification: E37
Suggested Citation: Suggested Citation