This model assumes that the price of the underlying asset can be approximated by a binomial process
. At each time interval, the price of the underlying asset moves up to (u) or down (d).
Following the binomial process
, the stock can take three possible values after two periods 2[DELTA]t : [u.sup.2] [S.sub.0], ud[S.sub.0], [d.sup.2][S.sub.0]; at the end of three periods 3[DELTA]t, the stock has four possible values: [u.sup.3][S.sub.0], [u.sup.2]d[S.sub.0], [ud.sup.2][S.sub.0], [d.sup.3][S.sub.0].
Subrahmanyam, 1984, "The Valuation of Options When Asset Returns Are Generated by a Binomial Process
", Journal of Finance, 39:1525-1539
The model assumes that the price of the underlying stock evolves according to a binomial process
and that exercise decisions are made so as to maximize the expected utility of the option holder's terminal wealth.
The negative binomial process
, on the other hand, seems appropriate for state or national assessment that involves more than one test grader.
Ramaswamy, "Simple binomial processes
as diffusion approximations in financial models," Review of Financial Studies, vol.
"Simple Binomial Processes
as Diffusion Approximation in Financial Models." Review: of Financial Studies 3 (3):393-430.