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Improving Convergence of Binomial Schemes and the Edgeworth Expansion

Author

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  • Alona Bock

    (Department of Mathematics, University of Kaiserslautern, 67663 Kaiserslautern, Germany)

  • Ralf Korn

    (Department of Mathematics, University of Kaiserslautern, 67663 Kaiserslautern, Germany
    Financial Mathematics, Fraunhofer ITWM, Fraunhofer Platz 1, 67663 Kaiserslautern, Germany)

Abstract

Binomial trees are very popular in both theory and applications of option pricing. As they often suffer from an irregular convergence behavior, improving this is an important task. We build upon a new version of the Edgeworth expansion for lattice models to construct new and quickly converging binomial schemes with a particular application to barrier options.

Suggested Citation

  • Alona Bock & Ralf Korn, 2016. "Improving Convergence of Binomial Schemes and the Edgeworth Expansion," Risks, MDPI, vol. 4(2), pages 1-22, May.
    • Handle: RePEc:gam:jrisks:v:4:y:2016:i:2:p:15-:d:70613
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    References listed on IDEAS

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    1. Yisong “Sam” Tian, 1999. "A flexible binomial option pricing model," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 19(7), pages 817-843, October.
    2. Ralf Korn & Stefanie Müller, 2013. "The optimal-drift model: an accelerated binomial scheme," Finance and Stochastics, Springer, vol. 17(1), pages 135-160, January.
    3. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    4. Broadie, Mark & Detemple, Jerome, 1996. "American Option Valuation: New Bounds, Approximations, and a Comparison of Existing Methods," The Review of Financial Studies, Society for Financial Studies, vol. 9(4), pages 1211-1250.
    5. Francine Diener & MARC Diener, 2004. "Asymptotics of the price oscillations of a European call option in a tree model," Mathematical Finance, Wiley Blackwell, vol. 14(2), pages 271-293, April.
    6. Dietmar Leisen & Matthias Reimer, 1996. "Binomial models for option valuation - examining and improving convergence," Applied Mathematical Finance, Taylor & Francis Journals, vol. 3(4), pages 319-346.
    7. Leduc, Guillaume, 2012. "Arbitrarily Fast CRR Schemes," MPRA Paper 42094, University Library of Munich, Germany, revised 20 Oct 2012.
    8. Lo-Bin Chang & Ken Palmer, 2007. "Smooth convergence in the binomial model," Finance and Stochastics, Springer, vol. 11(1), pages 91-105, January.
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    Cited by:

    1. Guillaume Leduc & Kenneth Palmer, 2023. "The Convergence Rate of Option Prices in Trinomial Trees," Risks, MDPI, vol. 11(3), pages 1-33, March.
    2. Yuan Hu & W. Brent Lindquist & Svetlozar T. Rachev & Frank J. Fabozzi, 2023. "Option pricing using a skew random walk pricing tree," Papers 2303.17014, arXiv.org.
    3. Guillaume Leduc & Merima Nurkanovic Hot, 2020. "Joshi’s Split Tree for Option Pricing," Risks, MDPI, vol. 8(3), pages 1-26, August.

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