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The Multinomial Option Pricing Model and Its Brownian and Poisson Limits

Dilip B. Madan¹; Frank Milne²; Hersh Shefrin³

¹ University of Maryland, College Park · ² Australian National University · ³ Santa Clara University

The Cox, Ross, and Rubinstein binomial model is generalized to the multinomial case. Limits are investigated and shown to yield the Black-Scholes formula in the case of continuous sample paths for a wide variety of complete market structures. In the discontinuous case of Merton-type formula is shown to result, provided jump probabilities are replaced by their corresponding Arrow-Debreu prices.

DOI

10.1093/rfs/2.2.251

Volume

2 (2)

Pages

251-265

Language

en

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BibTeX

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