Decision Tree and Microsoft Excel Approach for Option Pricing Model

Jow-Ran Chang and John Lee

Chapter 84 in Handbook of Investment Analysis, Portfolio Management, and Financial Derivatives:In 4 Volumes, 2024, pp 2683-2726 from World Scientific Publishing Co. Pte. Ltd.

Abstract: The main aims of this chapter are (i) to 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, Ross, and Rubinstein (CRR, 1979) and (ii) to 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 between binomial and trinomial tree is also compared. In sum, this chapter shows how binomial OPM can be converted step by step to Black–Scholes OPM.

Keywords: Financial Accounting; Financial Auditing; Mutual Funds; Hedge Funds; Asset Pricing; Options; Portfolio Analysis; Risk Management; Investment Analysis; Momentum Analysis; Behavior Analysis; Futures; Index Futures; CDCs; Financial Econometrics; Statistics; Financial Derivatives; Financial Accounting (search for similar items in EconPapers)
JEL-codes: G1 G11 G12 G3 M41 M42 (search for similar items in EconPapers)
Date: 2024
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