1.1 The Binomial Asset Pricing Model
The binomial asset pricing model provides a powerful tool to understand arbitrage pricing theory and probability theory. In this course, we shall use it for both these purposes.
In the binomial asset pricing model, we model stock prices in discrete time, assuming that at each step, the stock price will change to one of two possible values. Let us begin with an initial positive stock price S0. There are two positive numbers, d and u, with
0 < d < u