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A Pragmatic Guide to Real OptionsBinomial Trees, Risk-Neutral Pricing, and American Style Options

A Pragmatic Guide to Real Options: Binomial Trees, Risk-Neutral Pricing, and American Style Options [In the third chapter, binomial trees were introduced to price European style options in which the mean of the value of the moption at maturity was computed and then discounted to produce the price of the option (i.e., the option premium). Inputs for building the tree, U, D, P(U), and P(D), and the discount rate were provided for the exercise. In this chapter, the calculation of these pieces of the model will be revealed based on a model by Cox, Ross, and Rubinstein (1979). Further, risk-neutral pricing used within the binomial tree will be demonstrated to be a mathematical convenience and not a necessary condition for pricing options (i.e., there is no need for an assumption that all investors are risk neutral). Finally, the process for pricing an American style option with the binomial tree will be explained, which will allow for the pricing of real options in the next chapter.] http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png

A Pragmatic Guide to Real OptionsBinomial Trees, Risk-Neutral Pricing, and American Style Options

Arnold, Tom
Springer Journals — Nov 12, 2015
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30 pages

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Publisher
Palgrave Macmillan US
Copyright
© Palgrave Macmillan, a division of Nature America Inc. 2014
ISBN
978-1-349-48301-3
Pages
53 –83
DOI
10.1057/9781137391162_4
Publisher site
See Chapter on Publisher Site

Abstract

[In the third chapter, binomial trees were introduced to price European style options in which the mean of the value of the moption at maturity was computed and then discounted to produce the price of the option (i.e., the option premium). Inputs for building the tree, U, D, P(U), and P(D), and the discount rate were provided for the exercise. In this chapter, the calculation of these pieces of the model will be revealed based on a model by Cox, Ross, and Rubinstein (1979). Further, risk-neutral pricing used within the binomial tree will be demonstrated to be a mathematical convenience and not a necessary condition for pricing options (i.e., there is no need for an assumption that all investors are risk neutral). Finally, the process for pricing an American style option with the binomial tree will be explained, which will allow for the pricing of real options in the next chapter.]

Published: Nov 12, 2015

Keywords: Stock Price; Option Price; Stock Prex; Strike Price; Spot Price

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