Generalized Binomial Trees

21 Pages Posted: 9 Sep 1996 Last revised: 20 Nov 2008

See all articles by Jens Carsten Jackwerth

Jens Carsten Jackwerth

University of Konstanz - Department of Economics

Date Written: August 26, 1996

Abstract

In a novel approach, standard and implied binomial trees are completely specified in terms of two basic inputs: the ending nodal probability distribution and a linear weight function which governs the stochastic process resulting in that distribution. Several key economic principles, such as no interior arbitrage, are intuitively related to these basic inputs. A simple and computationally efficient three-step algorithm, common to all binomial trees, is found. Noting that the currently used linear weight function is unnecessarily restrictive, a binomial tree even more versatile is introduced, the generalized binomial tree. Applications to recovering the stochastic process implied in (European, American, or exotic) options of several times-to-expiration are developed.

JEL Classification: G13

Suggested Citation

Jackwerth, Jens Carsten, Generalized Binomial Trees (August 26, 1996). Journal of Derivatives, Vol. 5, No. 2, pp. 7-17, Available at SSRN: https://ssrn.com/abstract=752 or http://dx.doi.org/10.2139/ssrn.752

Jens Carsten Jackwerth (Contact Author)

University of Konstanz - Department of Economics ( email )

Universitaetsstr. 10
Konstanz, 78457
Germany
+497531882196 (Phone)
+497531883120 (Fax)

HOME PAGE: http://cms.uni-konstanz.de/wiwi/jackwerth/

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