Lattice-Based Model

AAA

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.

INVESTOPEDIA EXPLAINS '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. Implied Volatility - IV

    The estimated volatility of a security's price. In general, implied ...
  2. Option Pricing Theory

    Any model- or theory-based approach for calculating the fair ...
  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. Binomial Option Pricing Model

    An options valuation method developed by Cox, et al, in 1979. ...
  6. Endowment Effect

    The endowment effect describes a circumstance in which an individual ...
RELATED FAQS
  1. No results found.
Related Articles
  1. Options & Futures

    Implied Volatility: Buy Low And Sell High

    This value is an essential ingredient in the option pricing recipe.
  2. Options & Futures

    Understanding Option Pricing

    Take advantage of stock movements by getting to know these derivatives.
  3. Bonds & Fixed Income

    Accounting and Valuing Employee Stock Options

    Learn the different accounting and valuation treatments of ESOs, and discover the best ways to incorporate these techniques into your analysis of stock.
  4. Options & Futures

    Give Yourself More Options With Real Estate Options

    Real estate options have many benefits, including a smaller initial capital requirement.
  5. Options & Futures

    The Fancy Way To Diversify Your Portfolio: Precious Metal Options

    A guide with strategies on how to invest or trade in precious metals by using options.
  6. Options & Futures

    When And How To Take Profits On Options

    Here are the different criteria to ensure maximum profit taking while trading options.
  7. Options & Futures

    The Future Is Now: All About Futures ETFs

    A new security class - futures ETFs - is gaining popularity. We tell you how futures ETFs work and offer tips.
  8. Options & Futures

    How To Protect A Short Position With Options

    Short selling can be a risky endeavor, but the inherent risk of a short position can be mitigated significantly through the use of options.
  9. Options & Futures

    Sensitivity Analysis For Black-Scholes Pricing Model

    Trading options requires complex calculations, based on multiple parameters. Which factors impact option prices the most?
  10. Fundamental Analysis

    Examples To Understand The Binomial Option Pricing Model

    Binomial option pricing model, based on risk neutral valuation, offers a unique alternative to Black-Scholes. Here are detailed examples with calculations using Binomial model and explanation ...

You May Also Like

Hot Definitions
  1. Prepaid Expense

    A type of asset that arises on a balance sheet as a result of business making payments for goods and services to be received ...
  2. Gordon Growth Model

    A model for determining the intrinsic value of a stock, based on a future series of dividends that grow at a constant rate. ...
  3. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
  4. Law Of Supply

    A microeconomic law stating that, all other factors being equal, as the price of a good or service increases, the quantity ...
  5. Investment Grade

    A rating that indicates that a municipal or corporate bond has a relatively low risk of default. Bond rating firms, such ...
  6. Fringe Benefits

    A collection of various benefits provided by an employer, which are exempt from taxation as long as certain conditions are ...
Trading Center