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Randomized Binomial Tree and Pricing of American-Style Options

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  • Hu Xiaoping
  • Cao Jie

Abstract

Randomized binomial tree and methods for pricing American options were studied. Firstly, both the completeness and the no-arbitrage conditions in the randomized binomial tree market were proved. Secondly, the description of the node was given, and the cubic polynomial relationship between the number of nodes and the time steps was also obtained. Then, the characteristics of paths and storage structure of the randomized binomial tree were depicted. Then, the procedure and method for pricing American-style options were given in a random binomial tree market. Finally, a numerical example pricing the American option was illustrated, and the sensitivity analysis of parameter was carried out. The results show that the impact of the occurrence probability of the random binomial tree environment on American option prices is very significant. With the traditional complete market characteristics of random binary and a stronger ability to describe, at the same time, maintaining a computational feasibility, randomized binomial tree is a kind of promising method for pricing financial derivatives.

Suggested Citation

  • Hu Xiaoping & Cao Jie, 2014. "Randomized Binomial Tree and Pricing of American-Style Options," Mathematical Problems in Engineering, Hindawi, vol. 2014, pages 1-6, March.
    • Handle: RePEc:hin:jnlmpe:291737
    DOI: 10.1155/2014/291737
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