Lattice-Based Model

What is ‘Lattice-Based Model’

An option pricing model that involves the construction of a binomial tree to show the different paths that the underlying asset may take over the option’s life. A lattice model can take into account expected changes in various parameters such as volatility over the life of the options, providing more accurate estimates of option prices than the Black-Scholes model. The lattice model is particularly suited to the pricing of employee stock options, which have a number of unique attributes.

Explaining ‘Lattice-Based Model’

The lattice model’s flexibility in incorporating expected volatility changes is especially useful in certain circumstances, such as pricing employee options at early-stage companies. Such companies may expect lower volatility in their stock prices in the future as their businesses mature. This assumption can be factored into a lattice model, enabling more accurate option pricing than the Black-Scholes model, which inputs the same level of volatility over the life of the option.

Further Reading

  • A lattice-based model to evaluate variable annuities with guaranteed minimum withdrawal benefits under a regime-switching model – [PDF]
  • A comparison of lattice based option pricing models on the rate of convergence – [PDF]
  • American stochastic volatility call option pricing: A lattice based approach – [PDF]
  • Structural default modeling: A lattice-based approach – [PDF]
  • A Lattice‐Based Method for Pricing Electricity Derivatives Under the Threshold Model – [PDF]
  • Design and fabrication of periodic lattice-based cellular structures – [PDF]
  • A new lattice-based scheme for swing option pricing under mean-reverting regime-switching jump-diffusion processes – [PDF]
  • A non‐lattice pricing model of American options under stochastic volatility – [PDF]
  • Lattice-based risk minimization training for unsupervised language model adaptation – [PDF]