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Subordinated Binomial Option Pricing

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  • Carolyn W. Chang
  • Jack S. K. Chang
  • Yisong Sam Tian

Abstract

We extend the binomial option pricing model to allow for more accurate price dynamics while retaining computational simplicity. The asset price in each binomial period evolves according to two independent and successive Bernoulli trials on trade occurrence/nonoccurrence and up/down price movement. Subordination leads to a trinomial tree with stochastic volatility in calendar time. We derive utility‐dependent valuation results incorporating the leverage effect and test the model empirically.

Suggested Citation

  • Carolyn W. Chang & Jack S. K. Chang & Yisong Sam Tian, 2006. "Subordinated Binomial Option Pricing," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 29(4), pages 559-573, December.
    • Handle: RePEc:bla:jfnres:v:29:y:2006:i:4:p:559-573
    DOI: 10.1111/j.1475-6803.2006.00194.x
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    References listed on IDEAS

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    1. Jens Carsten Jackwerth and Mark Rubinstein., 1995. "Implied Probability Distributions: Empirical Analysis," Research Program in Finance Working Papers RPF-250, University of California at Berkeley.
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