Enhancing binomial and trinomial equity option pricing models

Young Shin Kim, Stoyan Stoyanov, Svetlozar Rachev and Frank Fabozzi ()

Finance Research Letters, 2019, vol. 28, issue C, 185-190

Abstract: We extend the classical Cox–Ross–Rubinstein binomial model in two ways. We first develop a binomial model with time-dependent parameters that equate all moments of the pricing tree increments with the corresponding moments of the increments of the limiting Itô price process. Second, we introduce a new trinomial model in the natural (historical) world, again fitting all moments of the pricing tree increments to the corresponding geometric Brownian motion. We introduce the risk-neutral trinomial tree and derive a hedging strategy based on an additional perpetual derivative used as a second asset for hedging at any node of the trinomial pricing tree.

Keywords: Cox-Ross-Rubinstein binomial model; geometric Brownian motion; Poisson process; Itô price process; trinomial model (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Working Paper: Enhancing Binomial and Trinomial Equity Option Pricing Models (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:28:y:2019:i:c:p:185-190

DOI: 10.1016/j.frl.2018.04.022

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