L.C.G. Rogers () (University of Bath, School of Mathematical Sciences, Bath BA2 7AY, Great Britain) E.J. Stapleton () (University of Bath, School of Mathematical Sciences, Bath BA2 7AY, Great Britain)
Additional information is available for the following
registered author(s):
We discuss here an alternative interpretation of the familiar binomial lattice approach to option pricing, illustrating it with reference to pricing of barrier options, one- and two-sided, with fixed, moving or partial barriers, and also the pricing of American put options. It has often been observed that if one tries to price a barrier option using a binomial lattice, then one can find slow convergence to the true price unless care is taken over the placing of the grid points in the lattice; see, for example, the work of Boyle & Lau [2]. The placing of grid points is critical whether one uses a dynamic programming approach, or a Monte Carlo approach, and this can make it difficult to compute hedge ratios, for example. The problems arise from translating a crossing of the barrier for the continuous diffusion process into an event for the binomial approximation. In this article, we show that it is not necessary to make clever choices of the grid positioning, and by interpreting the nature of the binomial approximation appropriately, we are able to derive very quick and accurate pricings of barrier options. The interpretation we give here is applicable much more widely, and helps to smooth out the `odd-even' ripples in the option price as a function of time-to-go which are a common feature of binomial lattice pricing.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Find related papers by JEL classification: G12 - Financial Economics - - General Financial Markets - - - Asset Pricing G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)