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Binomial options model

The Binomial options model provides a generalisable numerical method for the valuation of options[?]. It was first proposed by Cox, Ross and Rubinstein (1979).

The binomial model uses a "discrete-time framework" to trace the evolution of the option's key underlying variable via a binomial lattice (tree); the given evolution then forms the basis for the option valuation. In general, the value of the option at any node in the lattice is determined - given the option style - using the risk neutrality[?] assumption for the price of the underlying at that node, and the value of the option at the two later nodes (or the exercise value at a final node). The procees is iterative, starting at each final node, and then working backwards through the tree to t = 0, where the calculated value is the value of the option in question.

See also

  • Black-Scholes: binomial lattices are able to handle a variety of conditions for which Black-Scholes cannot be applied.
  • Financial mathematics, which has a list of related articles.

External links and References



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