Difference between revisions of "Binomial Option Pricing Model"
(Binomial option pricing is a simple but powerful technique that can be used to solve many complex option-pricing problems.) |
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| − | Binomial option pricing is a simple but powerful technique that can be used to solve many complex option-pricing problems. In contrast to the [[Black_Scholes_Model|Black-Scholes]] and other complex option-pricing models that require solutions to stochastic differential equations, the binomial option-pricing model (two state option-pricing model) is mathematically simple. It is based on the assumption of no arbitrage.<ref>What is Binomial Option Princing Model? [http://faculty.darden.virginia.edu/conroyb/derivatives/Binomial%20Option%20Pricing%20_f-0943_.pdf Dardan]</ref> | + | Binomial option [[pricing]] is a simple but powerful technique that can be used to solve many complex option-pricing problems. In contrast to the [[Black_Scholes_Model|Black-Scholes]] and other complex option-pricing models that require solutions to stochastic differential equations, the binomial option-pricing [[model]] (two state option-pricing model) is mathematically simple. It is based on the assumption of no arbitrage.<ref>What is Binomial Option Princing Model? [http://faculty.darden.virginia.edu/conroyb/derivatives/Binomial%20Option%20Pricing%20_f-0943_.pdf Dardan]</ref> |
| − | So in essence, the binomial option pricing model assumes a perfectly efficient market. Under this assumption, it is able to provide a mathematical valuation of an option at each point in the timeframe specified. The binomial model takes a risk-neutral approach to valuation and assumes that underlying security prices can only either increase or decrease with time until the option expires worthless.<ref>Explaining Binomial Option Princing Model[http://www.investopedia.com/terms/b/binomialoptionpricing.asp Investopedia]</ref> | + | So in essence, the binomial option pricing model assumes a perfectly efficient [[market]]. Under this assumption, it is able to provide a mathematical valuation of an option at each point in the timeframe specified. The binomial model takes a [[risk]]-neutral approach to valuation and assumes that underlying security prices can only either increase or decrease with time until the option expires worthless.<ref>Explaining Binomial Option Princing Model[http://www.investopedia.com/terms/b/binomialoptionpricing.asp Investopedia]</ref> |
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Latest revision as of 14:01, 6 February 2021
Binomial option pricing is a simple but powerful technique that can be used to solve many complex option-pricing problems. In contrast to the Black-Scholes and other complex option-pricing models that require solutions to stochastic differential equations, the binomial option-pricing model (two state option-pricing model) is mathematically simple. It is based on the assumption of no arbitrage.[1]
So in essence, the binomial option pricing model assumes a perfectly efficient market. Under this assumption, it is able to provide a mathematical valuation of an option at each point in the timeframe specified. The binomial model takes a risk-neutral approach to valuation and assumes that underlying security prices can only either increase or decrease with time until the option expires worthless.[2]
References
- ↑ What is Binomial Option Princing Model? Dardan
- ↑ Explaining Binomial Option Princing ModelInvestopedia