On the Relation Between Binomial and Trinomial Option Pricing Models

The original binomial option pricing procedure has been both an extremely valuable pedagogical tool for explaining the principles of derivatives valuation, and also a major workhorse in practical trading applications. But particularly for the latter, other numerical approximation techniques, like the trinomial lattice approach or finite-difference methods, are widely used and often felt to be better suited to more complex derivatives problems. In this article, Rubinstein examines the connection between the binomial model and the explicit finite difference technique (which itself encompasses the trinomial model), and shows that, in fact, the binomial can be thought of as a special case of the explicit finite-difference model.