MULTIVARIATE BINOMIAL APPROXIMATIONS FOR ASSET PRICES WITH NONSTATIONARY VARIANCE AND COVARIANCE CHARACTERISTICS

In this article, we suggest an efficient method of approximating a gen eral, multivariate lognormal distribution by a multivariate binomial p rocess. There are two important features of such multivariate distribu tions. First, the state variables may have volatilities that change ov er time Second the two or more relevant state variables involved may c ovary with each other in a specified manner, with a time-varying covar iance structure. We discuss the asymptotic properties of the resulting processes and show bow the methodology can be used to value a complex , multiple exerciseable option whose payoff depends on the prices of t wo assets.