Can High-Order Convergence of European Option Prices be Achieved with Common CRR-Type Binomial Trees?

Considering European call options, we prove that CRR-type binomial trees systematically underprice the value of these options, when the spot price is not near the money. However, we show that, with a volatility premium to compensate this mispricing, any arbitrarily high order of convergence can be a...

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Bibliographic Details
Published inBulletin of the Malaysian Mathematical Sciences Society Vol. 39; no. 4; pp. 1329 - 1342
Main Author Leduc, Guillaume
Format Journal Article
LanguageEnglish
Published Singapore Springer Singapore 01.10.2016
Springer Nature B.V
Subjects
Applications of Mathematics
Convergence
Mathematics
Mathematics and Statistics
Options trading
Put & call options
Securities prices
Trees
Volatility
G13
60J20
Option
Rate of convergence
Binomial tree
91G20
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Summary:Considering European call options, we prove that CRR-type binomial trees systematically underprice the value of these options, when the spot price is not near the money. However, we show that, with a volatility premium to compensate this mispricing, any arbitrarily high order of convergence can be achieved, within the common CRR-type binomial tree framework.
ISSN:0126-6705
2180-4206
DOI:10.1007/s40840-015-0221-2