An Improved Binomial Lattice Method for Multi-Dimensional Options
AbstractA binomial lattice approach is proposed for valuing options whose payoff depends on multiple state variables following correlated geometric Brownian processes. The proposed approach relies on two simple ideas: a log-transformation of the underlying processes, which is step by step consistent with the continuous-time diffusions, and a change of basis of the asset span, to transform asset prices into uncorrelated processes. An additional transformation is applied to approximate driftless dynamics. Even if these features are simple and straightforward to implement, it is shown that they significantly improve the efficiency of the multi-dimensional binomial algorithm. A thorough test of efficiency is provided compared with most popular binomial and trinomial lattice approaches for multi-dimensional diffusions. Although the order of convergence is the same for all lattice approaches, the proposed method shows improved efficiency.
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Bibliographic InfoArticle provided by Taylor & Francis Journals in its journal Applied Mathematical Finance.
Volume (Year): 14 (2007)
Issue (Month): 5 ()
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Other versions of this item:
- Andrea Gamba & Lenos Trigeorgis, 2007. "An Improved Binomial Lattice Method for Multi-Dimensional Options," Working Papers wpn07-01, Warwick Business School, Finance Group.
- JEL - Labor and Demographic Economics - - - - -
- cla - - - - - -
- : -
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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