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On the enhanced convergence of standard lattice methods for option pricing

✍ Scribed by Martin Widdicks; Ari D. Andricopoulos; David P. Newton; Peter W. Duck

Publisher
John Wiley and Sons
Year
2002
Tongue
English
Weight
200 KB
Volume
22
Category
Article
ISSN
0270-7314

No coin nor oath required. For personal study only.

✦ Synopsis

Abstract

For derivative securities that must be valued by numerical techniques, the trade‐off between accuracy
and computation time can be a severe limitation. For standard lattice methods, improvements are achievable by
modifying the underlying structure of these lattices; however, convergence usually remains
non‐monotonic. In an alternative approach of general application, it is shown how to use standard
methods, such as Cox, Ross, and Rubinstein (CRR), trinomial trees, or finite differences, to produce
uniformly converging numerical results suitable for straightforward extrapolation. The concept of Λ, a
normalized distance between the strike price and the node above, is introduced, which has wide ranging
significance. Accuracy is improved enormously with computation times reduced, often by orders of magnitude.
© 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:315–338, 2002

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