ABSTRACT
The one-period trinomial tree is shown in Figure 6.1. This structure is reproduced at each time-step to generate a tree in which each vertex has three "offspring." A necessary and sufficient condition for the tree to recombine is that the parameters U , M, and D satisfy
We assume, without loss of generality, that these parameters are given by the formulas
Here and i 7 are constants (with 77 >0) that will be determined later and d t represents a (small) interval of time between successive shocks (measured in years).
