The Classical and Stochastic Approach to Option Pricing
The Classical and Stochastic Approach to Option Pricing

Author(s): Martin Cupal, Luděk Benada
Subject(s): Methodology and research technology, Financial Markets
Published by: Masarykova univerzita nakladatelství
Keywords: option pricing; lattices; Black-Scholes model; volatility; Geometric Brownian motion;
Summary/Abstract: Black-Scholes model (BS) and lattices are well-known methodologies applied to option pricing, with their own specific features and properties. Briefly, lattices are discrete in the inner computing process and stochastically based, while BS is represented by a continuous functional form without single steps, but deterministic only. The strong assumption of constant volatility and the inability of application in valuing “American”options represent major disadvantages of the BS model. Its main advantage is its simplicity and ease of application. The use of Monte Carlo simulations constitutes an alternative to this model.

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