2014•Value EngineeringRequires access

A Trinomial Tree Pricing Model Based on the Risk-neutral Probability

Yali Yuan

Abstract

The tree model is a practical method for pricing vanilla European and American options and the most popular one is binomial model. As an extending of binomial model and based on the risk-neutral probability, trinomial model is also used to price vanilla options. It can be implemented in MATLAB as well. Compared with the outcomes of binomial model, the pricing outcomes of trinomial model converge better to B-S-M analytic solution. Besides, sensitivity analysis can be conducted to test the influential factors of option price by using trinomial model and demonstrate the reasonability of this model.

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Available abstract

Key concepts: Trinomial, Trinomial tree, Binomial options pricing model, Binomial (polynomial), Econometrics, Mathematics, Valuation of options, Finite difference methods for option pricing