Lattice-Based Model


DEFINITION of '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.

BREAKING DOWN '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.

  1. Implied Volatility - IV

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  2. Binomial Option Pricing Model

    An options valuation method developed by Cox, et al, in 1979. ...
  3. Black Scholes Model

    A model of price variation over time of financial instruments ...
  4. Binomial Tree

    A graphical representation of possible intrinsic values that ...
  5. Option Pricing Theory

    Any model- or theory-based approach for calculating the fair ...
  6. Rule Of 72

    A shortcut to estimate the number of years required to double ...
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