Two-state option pricing: Binomial models revisited

This article revisits the topic of two-state option pricing. It examines th e models developed by Cox, Ross, and Rubinstein (1979), Rendleman and Bartt er (1979), and Trigeorgis (1991) and presents two alternative binomial mode ls based on the continuous-time and discrete-time geometric Brownian motion processes, respectively. This work generalizes the standard binomial appro ach, incorporating the main existing models as particular cases. The propos ed models are straightforward and flexible, accommodate any drift condition , and afford additional insights into binomial trees and lattice models in general. Furthermore, the alternative parameterizations are free of the neg ative aspects associated with the Cox, Ross, and Rubinstein model. (C) 2001 John Wiley & Sons, Inc.