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cerberus
Topic Author
Posts: 1
Joined: April 6th, 2007, 3:35 am

Comparison between Black's approximation and Binomial Model

In Hull's Book, difference between Black's approximation and Binomial model regarding the pricing of dividend-paying American option is discussed. Hull says " the way in which volatility is applied tends to make BA greater than BM". I know for BA, the volatility applies to the dividend-adjusted stock price, but I don't understand how BM differs from BA. Any response would be appreciated.

quantmeh
Posts: 5974
Joined: April 6th, 2007, 1:39 pm

Comparison between Black's approximation and Binomial Model

QuoteOriginally posted by: cerberusAny response would be appreciated.i'd suggest you to write the three-period tree with dividend payment right after period two by hand on paper, you'll see the difference immediately. don't forget to adjust the risk-neutral probabilities in period two.