Non-recombining trees for pricing of multi-variate options
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.