MULTIVARIATE BINOMIAL APPROXIMATIONS FOR ASSET PRICES WITH NONSTATIONARY VARIANCE AND COVARIANCE CHARACTERISTICS

Teng-Suan Ho, Richard C. Stapleton and Marti G. Subrahmanyam
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Teng-Suan Ho: Department of Accounting and Finance, The Management School, Lancaster University, Lancaster LA1 4YX, England, UK
Richard C. Stapleton: Department of Accounting and Finance, The Management School, Lancaster University, Lancaster LA1 4YX, England, UK
Marti G. Subrahmanyam: New York University, Stern School of Business, 44 West 4th Street, New York City, NY 10012, USA

Chapter 1 in Quantitative Analysis in Financial Markets:Collected Papers of the New York University Mathematical Finance Seminar, 1999, pp 1-24 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractIn this article, we suggest an efficient method of approximating a general, multivariate lognormal distribution by a multivariate binomial process. There are two important features of such multivariate distributions. First, the state variables may have volatilities that change over time. Second, the two or more relevant state variables involved may covary with each other in a specified manner, with a time-varying covariance structure. We discuss the asymptotic properties of the resulting processes and show how the methodology can be used to value a complex, multiple exerciseable option whose payoff depends on the prices of two assets.

Date: 1999
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