Derivatives Markets and Analysis

CHAPTER 10The Binomial Option Pricing Model

The two most widely used models for determining the equilibrium price of an option are the Black and Scholes (B‐S) option pricing model (OPM) and the binomial option pricing model (BOPM). Black and Scholes derived their model in 1973 in a seminal paper in the Journal of Political Economy. The BOPM was discussed first by Stone (1973) and Sharpe (1978), then formalized by Cox, Ross, and Rubinstein (1979) and Rendleman and Bartter (1979). The models are similar in a number of ways. The major differences are the assumptions each makes concerning the underlying security price's fluctuations over time. In the BOPM, the time to expiration is partitioned into a discrete number of periods, each with the same ...