Lean Trees—A General Approach for Improving Performance of Lattice Models for Option Pricing

Authors: Baule R.¹; Wilkens M.²

Source: Review of Derivatives Research, Volume 7, Number 1, 2004 , pp. 53-72(20)

Publisher: Springer

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Abstract:

The well-known binomial and trinomial tree models for option pricing are examined from the point of view of numerical efficiency. Common lattices use a large part of time resources for calculations which are almost irrelevant for the solution. To avoid this waste of resources, the tree is reduced to a “lean” form which yields the same order of convergence, but with a reduction of numerical effort. In numerical tests it is shown that the proposed method leads to a significant improvement in real calculation time without loss of accuracy for a broad class of derivatives.

Keywords: Lean trees; lattice models; option pricing; numerical valuation techniques

Document Type: Research article

DOI: http://dx.doi.org/10.1023/B:REDR.0000017028.57712.19

Affiliations: 1: Institute of Finance and Banking, University of Göttingen, Platz der Göttinger Sieben 5, D-37073 Göttingen, Germany 2: Chair of Finance and Banking, Catholic University of Eichstätt-Ingolstadt, Auf der Schanz 49, D-85049 Ingolstadt, Germany, Email: Marco.Wilkens@KU-Eichstaett.de

Publication date: 2004-01-01