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A discrete-time lattice model that values options by backward induction from terminal payoffs.
A discrete-time lattice model that values options by backward induction from terminal payoffs.
Introduced by Cox, Ross, and Rubinstein (1979), the binomial model represents price evolution as a recombining tree of up and down moves. With sufficiently many time steps it converges to Black-Scholes for European options and natively handles American exercise, discrete dividends, and path-independent exotics.
Risk-neutral probability p = (e^{r \Delta t} - d) / (u - d); u = e^{\sigma \sqrt{\Delta t}}, d = 1/u.
Native handling of American-style early exercise and discrete dividend payments.
Foundation for more sophisticated lattice methods (trinomial, adaptive mesh).