Extend the Binomial Option Pricing Full-Scale Estimation model to determine how fast the binomial option price
Question:
Extend the Binomial Option Pricing – Full-Scale Estimation model to determine how fast the binomial option price with averaging of adjacent odd and even numbers of periods converges to the price in the Black-Scholes Option Pricing – Basics model. As you increase the number of periods in the binomial model, it oscillates between overshooting and undershooting the true price. A simple technique to increase price efficiency is to average adjacent odd and even numbers of periods. For example, average the 10 period call price and the 11 period call price. Reduce the Full-Scale model to a 10 period, 11 period, 20 period, and 21 period model. Increase the 50 period model to a 51 period, 100 period, and 101 period model. Then for the same inputs, compare call and put prices of the average of the 10 and 11 period models, 20 and 21 period models, 50 and 51 period models, 100 and 101 period models, and Black-Scholes model.
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