Business Accounting and Bookkeeping
Mathematical Finance
Niels Bohr

What are the shortcomings of the binomial pricing model?

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Wiki User
2007-06-25 10:51:03

b) Binomial pricing model doesnt provide for the possibility of

price of the underlying remaining the same between two consecutive

time points (it assumes that either the price could go up or could

come down; it completely ignores the possibility of the price not

changing at all) a) Binomial pricing model breaks up the time to

the expiry of option in to a limited number of time intervals and

hence, the price calculated through binomial trees is more of a

broad approximation of the actual price. (Compare this with Black

Scholes (BS) Model which gives a more accurate approximation

because the BS model involves breaking the time to expiry into

infinitesimaly small time intervals).

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