An Alternative Method of Options Pricing by Implied Trees
Date Issued
2009
Date
2009
Author(s)
Tsai, Tsung-Yu
Abstract
This thesis proposes a constant probability-stochastic volatility implied binomial tree. Our method improves upon some weaknesses of previous works. Compared with the Derman-Kani tree (1994) and the Li tree (2000), our method is considerably more stable. In our method, neither the nvalid transition probability problem occurs, like in the Derman-Kani tree, nor the results of option pricing diverge when the slope of volatility with respect to the strike price is steep, as in the Li tree. Incorporating thenown local volatility function, our method constructs the implied binomial tree directly by forward induction. The option value is calculated from the stock prices in the terminal nodes of the tree backward. As a whole, for the proposed constant probability-stochastic volatility implied binomial tree, its construction is direct, and itsmplementation is straightforward.
Subjects
volatility smile
volatility surface
implied tree
binomial tree
Type
thesis
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