Accuracy of the binomial asset pricing model using daily volatilities
DOI:
https://doi.org/10.14288/cjur.v1i1.201777Abstract
The binomial asset pricing model is well established, having been developed in 1979 by John C. Cox, Stephen A. Ross, and Mark Rubinstein. In their paper “Option pricing: a simplified approach”, they propose that stock prices can be modeled by probabilities of price increase or decrease by a set amount in a time period depending on the volatility of the stock. While they used constant volatilities for their calculations, it has been identified by many other scholars that the assumption of constant volatility reflects the market poorly, and that stochastic volatility serves the purpose better. This article compares the accuracy of the model stock prices using daily volatility values with using a constant volatility to historical stock prices in attempts to show that daily volatility rates represent the market better.
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