The Rate of Convergence of Binomial Lattice Models for Pricing Vanilla Options

28 Pages Posted: 17 Jun 2013 Last revised: 15 Sep 2014

See all articles by Mark S. Joshi

Mark S. Joshi

University of Melbourne - Centre for Actuarial Studies (deceased)

Chun Fung Kwok

St. Vincent's Institute of Medical Research

Date Written: November 25, 2011

Abstract

Variations of the binomial tree model are reviewed and extensions to the two most efficient trees studied in a recent literature are proposed. Tian’s modified tree is extended to a more general class of tree, and the third order tree is extended to the seventh order tree. Analysis of the error of American put pricing in the binomial tree model is presented and new trees that have superior performance in pricing in-the-money American puts are developed. To further improve numerical results, a scheme that incorporates different trees is suggested.

Keywords: American put option, rate of convergence, binomial trees

JEL Classification: G13

Suggested Citation

Joshi, Mark and Kwok, Chun Fung, The Rate of Convergence of Binomial Lattice Models for Pricing Vanilla Options (November 25, 2011). Available at SSRN: https://ssrn.com/abstract=2277854 or http://dx.doi.org/10.2139/ssrn.2277854

Mark Joshi

University of Melbourne - Centre for Actuarial Studies (deceased) ( email )

Melbourne, 3010
Australia

Chun Fung Kwok (Contact Author)

St. Vincent's Institute of Medical Research

Australia

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