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.

RELATED TERMS
  1. Option Pricing Theory

    Any model- or theory-based approach for calculating the fair ...
  2. Black's Model

    A variation of the popular Black-Scholes options pricing model ...
  3. Binomial Option Pricing Model

    An options valuation method developed by Cox, et al, in 1979. ...
  4. Implied Volatility - IV

    The estimated volatility of a security's price.
  5. Model Risk

    A type of risk that occurs when a financial model used to measure ...
  6. Trinomial Option Pricing Model

    An option pricing model incorporating three possible values that ...
Related Articles
  1. Trading

    Breaking Down The Binomial Model To Value An Option

    Find out how to carve your way into this valuation model niche.
  2. Trading

    Circumvent Limitations of Black-Scholes Model

    Mathematical or quantitative model-based trading continues to gain momentum, despite major failures like the financial crisis of 2008-09, which was attributed to the flawed use of trading models. ...
  3. Investing

    Understanding the Black-Scholes Model

    The Black-Scholes model is a mathematical model of a financial market. From it, the Black-Scholes formula was derived. The introduction of the formula in 1973 by three economists led to rapid ...
  4. Trading

    The "True" Cost Of Stock Options

    Perhaps the real cost of employee stock options is already accounted for in the expense of buyback programs.
  5. Trading

    The Volatility Surface Explained

    Learn about stock options and the "volatility surface," and discover why it is an important concept in stock options pricing and trading.
  6. Trading

    How To Build Valuation Models Like Black-Scholes (BS)?

    Want to build a model like Black-Scholes? Here are the tips and guidelines for developing a framework with the example of the Black-Scholes model.
  7. Trading

    The Anatomy of Options

    Find out how you can use the "Greeks" to guide your options trading strategy and help balance your portfolio.
  8. Investing

    Using Decision Trees In Finance

    These decision-making tools play an integral role in corporate finance and economic forecasting.
  9. Trading

    Stock Options: What's Price Got To Do With It?

    A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
RELATED FAQS
  1. What is the average return on equity for a company in the electronics sector?

    Learn about the Black-Scholes option pricing model and the binomial options model, and understand the advantages of the binomial ... Read Answer >>
  2. How is implied volatility for options impacted by a bearish market?

    Learn why implied volatility for option prices increases during bear markets, and learn about the different models for pricing ... Read Answer >>
  3. How is implied volatility used in the Black-Scholes formula?

    Learn how implied volatility is used in the Black-Scholes option pricing model, and understand the meaning of the volatility ... Read Answer >>
  4. Can delta be used to calculate price volatility of an option?

    Learn how implied volatility is an output of the Black-Scholes option pricing formula, and learn about that option formula's ... Read Answer >>
  5. How does implied volatility impact the pricing of options?

    Learn about two specific volatility types associated with options and how implied volatility can impact the pricing of options. Read Answer >>
  6. What technical skills must one possess to trade options?

    Learn about the technical skills required to trade options and how mathematical and computer science skills give you a better ... Read Answer >>
Hot Definitions
  1. IRS Publication 970

    A document published by the Internal Revenue Service (IRS) that provides information on tax benefits available to students ...
  2. Federal Direct Loan Program

    A program that provides low-interest loans to postsecondary students and their parents. The William D. Ford Federal Direct ...
  3. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  4. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  5. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  6. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
Trading Center