Template-Type:ReDIF-Paper 1.0  
Title: Binomial Models for Option Valuation - Examining and Improving Convergence 
Author-Name: Leisen, D. P. J. 
Author-Name: M. Reimer 
Classification-JEL:G13
Keywords:binomial model, option valuation, order of convergence, convergence pattern 
Abstract:Binomial models, which rebuild the continuous setup in the limit, serve for approximative valuation of
	options, especially where formulas cannot be derived mathematically. Even with the valuation of European call
	options distorting irregularities occur. For this case, sources of convergence patterns are explained. Furthermore, it
	is proved order of convergence one for the Cox-Ross-Rubinstein[79] model as well as for the tree parameter
	selections of Jarrow and Rudd[83], and Tian[93]. Then, we define new binomial models, where the calculated
	option prices converge smoothly to the Black-Scholes solution and remarkably, we even achieve order of
	convergence two with much smaller initial error. Notably, solely the formulas to determine the constant up- and
	down-factors change. Finally, all tree approaches are compared with respect to speed and accuracy calculating
	relative root-mean-squared error of approximative option values for a sample of randomly selected parameters
	across a set of refinements. Approximation of American type options with the new models exhibits order of
	convergence one but smaller initial error than previously existing binomial models. 
Length: pages
Creation-Date: 1995-03
Revision-Date: 
Handle: RePEc:bon:bonsfb:309
File-URL: http://www.wiwi.uni-bonn.de/bgsepapers/bonsfb/bonsfb309.pdf
File-Format: application/pdf
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