Binomial Tree

Binomial trees are often used in the pricing of financial derivatives. The price of the asset underlying the derivative (for instance, the stock price in the case of a stock option) is assumed to follow an evolution such that, in each period in time, it increases by a fixed proportion or decreases by another fixed proportion. These fixed proportions are labeled above as the "up factor" and the "down factor". The tree traces out all possible price histories of the underlying asset.


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