When using the binomial pricing model to price an option, the volatility of the underlying asset is represented by the difference between the two possible future values of the underlying asset.

Question

Quizplus · Accepted Answer

The binomial pricing model assumes that the value of the underlying asset can move up or down by a certain percentage in each period. The volatility is represented by the size of these percentage movements, rather than the difference between the two possible future values of the underlying asset.

When Using the Binomial Pricing Model to Price an Option