Constructing a binomial tree
Hey guys,
I have a question based on an example from Schweser's study notes. This is probably something really simple but I'm not sure why it doesn't make sense.
on page 247 of the first book an example is demonstrated with probability of a stock price going up as "P" and the price going down as "(1- p)", so only 2 possible outcomes since we're dealing with a binomial distribution. It assumes that the stock will either increase in value by 1% or decrease in value by 1% and states the up-move factor as 1.01, which makes perfect sense but provides the down-move factor as 1/1.01, which does not make sense. For the stock to go down 1% shouldn't the down-move factor be 0.99 and not 0.990099009=1/1.01?
Obviously if a stock goes down 1% today, and up 1% tomorrow, the stock will not be at it's initial trading price and would need to go higher by more than 1% on the second day to get back to that initial value. But using the down move factor of 1/1.01 would leave the stock value unchanged in such scenario.
A quick explanation would be very much appreciated.
Rina |
发表于 2011-7-13 16:49
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