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On Simple Binomial Approximations for Two Variable Functions in Finance Applications

In: Advances In Quantitative Analysis Of Finance And Accounting

Author

Listed:
  • Hemantha S. B. Herath

    (Department of Accounting, Brock University, Faculty of Business, Taro Hall 240, 500 Glenridge Ave, St. Catharines,Ontario, Canada L2S 3A1, Canada)

  • Pranesh Kumar

    (College of Science and Management, University of Northern British Columbia, 3333 University Way, Prince George, British Columbia, Canada V2N 4Z9, Canada)

Abstract

We extend the volatility stabilization transformation technique to two correlated Brownian motions. This technique allows to construct a computationally simple binomial tree and to obtain the probabilities for the up and down movements. We derive the expressions for correlated geometric Brownian motions by considering two variable functions. We discuss particular functions of two variables, which are commonly employed in finance. Further, we simulate results for the numerical accuracy of the approximations using an exchange option.

Suggested Citation

  • Hemantha S. B. Herath & Pranesh Kumar, 2007. "On Simple Binomial Approximations for Two Variable Functions in Finance Applications," World Scientific Book Chapters, in: Cheng-Few Lee (ed.), Advances In Quantitative Analysis Of Finance And Accounting, chapter 8, pages 163-179, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789812772213_0008
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