Abstract
We generalize the Rubinstein (1994) risk-neutral implied binomial tree (R-IBT) model to a physical-world risk-averse implied binomial tree (RA-IBT) model. The R-IBT and RA-IBT trees are bound together via a relationship requiring a risk premium (or a risk-adjusted discount rate) on the underlying asset at any node. The RA-IBT provides a powerful numerical platform for many empirical financial option and real option applications; these include probabilistic inference, pricing, and utility theory applications.
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© 2011 Tom Arnold, Timothy Falcon Crack, and Adam Schwartz
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Arnold, T., Crack, T.F., Schwartz, A. (2011). Inferring Risk-Averse Probability Distributions from Option Prices Using Implied Binomial Trees. In: Gregoriou, G.N., Pascalau, R. (eds) Financial Econometrics Modeling: Derivatives Pricing, Hedge Funds and Term Structure Models. Palgrave Macmillan, London. https://doi.org/10.1057/9780230295209_2
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DOI: https://doi.org/10.1057/9780230295209_2
Publisher Name: Palgrave Macmillan, London
Print ISBN: 978-1-349-32892-5
Online ISBN: 978-0-230-29520-9
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