Working Paper
Binomial Approximation in Financial Models: Computational Simplicity and Convergence
This paper explores the potential of transformation and other
schemes in constructing a sequence of simple binomial processes that
weakly converges to the desired diffusion limit. Convergence results
are established for valuing both European and American contingent claims
when the underlying asset prices are approximated by simple binomial
processes. We also demonstrate how to construct reflecting and
absorbing binomial processes to approximate diffusions with boundaries.
Numerical examples show that the proposed simple approximations not only
converge, but also give more accurate results than existing methods,
such as that of Nelson and Ramaswamy (1990), especially for longer
maturities.
Suggested Citation
Li, Anlong. 1992. “Binomial Approximation in Financial Models: Computational Simplicity and Convergence.” Federal Reserve Bank of Cleveland, Working Paper No. 92-01. https://doi.org/10.26509/frbc-wp-199201
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