Determine the value of u for a three period binomial problem when the option's life is one-half a year and the volatility is 0.48.Use the model for u that does not require the risk-free rate.
A)1.22
B)1.48
C)1.40
D)1.32
E)none of the above

Question

Quizplus · Accepted Answer

The value of u in a binomial model is calculated as $ u = e^{\sigma \sqrt{\Delta t}} $, where $\sigma$ is the volatility and $\Delta t$ is the length of each period. Here, $\sigma = 0.48$ and $\Delta t = \frac{1}{3}$ (since the option's life is half a year and there are three periods). Thus, $ u = e^{0.48 \sqrt{\frac{1}{3}}} \approx 1.22 $.

Determine the Value of U for a Three Period Binomial