Backward option pricing

At each node of a binomial tree, a claim with next-period values

V_{u}, V_{d}

has value

V = \frac{q V _{u} + ( 1 - q ) V _{d}}{1 + r},

where

q

is the local risk-neutral probability in a binomial market. For an American claim, replace this continuation value by the maximum of continuation and immediate exercise value.

 Ancestors (8)

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