Decision Tree and Microsoft Excel Approach for Option Pricing Model

Jow-Ran Chang and John Lee

Chapter 84 in Handbook of Financial Econometrics, Mathematics, Statistics, and Machine Learning:(In 4 Volumes), 2020, pp 2885-2927 from World Scientific Publishing Co. Pte. Ltd.

Abstract: In this chapter, we (i) use the decision-tree approach to derive binomial option pricing model (OPM) in terms of the method used by Rendleman and Barter (RB, 1979) and Cox et al. (CRR, 1979) and (ii) use Microsoft Excel to show how decision-tree model can be converted to Black–Scholes model when the number period increases to infinity. In addition, we develop binomial tree model for American option and trinomial tree model. The efficiency of binomial and trinomial tree methods is also compared. In sum, this chapter shows how binomial OPM can be converted step by step to Black–Scholes OPM.

Keywords: Financial Econometrics; Financial Mathematics; Financial Statistics; Financial Technology; Machine Learning; Covariance Regression; Cluster Effect; Option Bound; Dynamic Capital Budgeting; Big Data (search for similar items in EconPapers)
JEL-codes: C01 C1 G32 (search for similar items in EconPapers)
Date: 2020
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