ABSTRACT

Lattice methods are among the most common and long-established methods for the pricing of derivative financial instruments, going back to the seminal work of Cox, Ross and Rubinstein, who introduced the binomial lattice model for option pricing. This chapter considers two broad classes of models: binomial models for a single underlying and models for the term structure of interest rates. It discusses the pricing of standard and exotic derivatives in these models and reflects the common concepts linking all lattice models in the C++ implementation. The first arbitrage–free term structure model to appear in the literature was Ho and Lee. In this model, the risk–neutral transition probabilities are set exogenously and are constant in time and states.