As the number of steps in the CRR binomial tree increases (keeping maturity fixed), the solution "converges" to a limit result. Which of the following statements characterizes this convergence best?
A) The solution results in the Black-Scholes formula.
B) The convergence may be oscillatory for even and odd number of steps in the tree.
C) The convergence may be monotonic for even and odd number of steps in the tree.
D) All of the above.

Question

Quizplus · Accepted Answer

The CRR binomial tree model, as the number of steps increases, indeed converges to the Black-Scholes formula, which is a continuous model for option pricing. This convergence can be oscillatory for even and odd numbers of steps, meaning the solution can slightly overshoot and undershoot as the number of steps changes. This behavior illustrates that the convergence is not strictly monotonic but can still lead to the same limit result, the Black-Scholes formula, demonstrating the robustness of the CRR model in approximating continuous processes.

As the Number of Steps in the CRR Binomial Tree