Deck 10 – Binomial Model

In the one-period binomial model, what is the risk-neutral up-state probability $q$?

$q=\frac{(1+r)-R_d}{R_u-R_d}$.

How is a derivative priced once risk-neutral probabilities are known in a one-period binomial model?

Discount the risk-neutral expected payoff at the risk-free rate.

What is the one-period binomial pricing formula for a call option?

$C_0=\frac{q{C}^{+}+(1-q)C^{-}}{1+r}$.

What is the one-period binomial pricing formula for a put option?

$P_0=\frac{q{P}^{+}+(1-q)P^{-}}{1+r}$.