During class today, we showed how the multi-timestep binomial option pricing formula (also known as the Cox-Ross-Rubinstein, or CRR model) converges in the limit (as the number of timesteps n become arbitrarily large and the length of each timestep becomes arbitrarily small) to the famous (and Nobel-prize winning) Black-Scholes-Merton (BSM) option pricing formula. Speaking of BSM, allow me to shamelessly plug a journal article that I published early in my academic career which Professor Robert C. Merton cites in his Nobel Prize lecture (Merton shared the Nobel Prize in economics in 1997 with Myron Scholes “for a new method to determine the value of derivatives”).
Here’s the citation (and link) to Merton’s lecture:
Merton, Robert C., 1998, Applications of Option-Pricing Theory: Twenty-Five Years Later, The American Economic Review, Vol. 88, No. 3 (Jun. 1998), pp. 323-349.
See page 337, footnote 11 of Merton’s paper for the reference to Neil A. Doherty and James R. Garven (1986)… (Doherty and I “pioneered” the application of a somewhat modified version of the BSM model to the pricing of insurance; thus Merton’s reference to our Journal of Finance paper in his Nobel Prize lecture)…