An option pricing method that models the underlying asset's price movement as a series of discrete up or down steps over time, creating a tree-like structure of possible price paths. This approach allows for more flexible modeling of American-style options and dividend payments.
From Latin 'bi-' meaning 'two' and Greek 'nomos' meaning 'law/distribution,' referring to the two possible price movements at each step. Developed by Cox, Ross, and Rubinstein in 1979 as a discrete-time alternative to the continuous Black-Scholes model.
The binomial model is like playing a giant game of 'choose your own adventure' with stock prices - at each step, the price can only go up or down by specific amounts, creating a tree of all possible futures! What's clever is that as you make the time steps smaller and smaller, this simple up-down model actually converges to the sophisticated Black-Scholes formula.
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