Non-recombining trees for pricing of multi-variate options

Michal Kaut*
Stein W. Wallace*

March 24, 2003

This paper presents a method for pricing multi-variate options using non-recombining trees. The trees are generated using a moment-based approach, so no distributional assumptions are needed. To apply the method, the user has to know the properties (moments and correlations) of the risk-neutral distributions of returns of all the assets the options depend on.

European options are priced on single-period trees, the path-dependent options on multi-period trees. We provide exact formulas for generation of trees without any inter-period dependency of the return distributions. With inter-period dependency, we provide only an ex-post correction procedure.

Keywords: non-recombining trees, option pricing, multivariate options

Molde University College, Postboks 2110, N-6402 Molde, Norway.