How can I use a binomial tree to price a European option that's based on a portfolio of equity products? I have volatility and correlation matrix of all underlying products?
Looking for a formula based solution so that I use in Matlab. Thanks.
How can I use a binomial tree to price a European option that's based on a portfolio of equity products? I have volatility and correlation matrix of all underlying products?
Looking for a formula based solution so that I use in Matlab. Thanks.
Under the typical Black-Scholes model, you "cannot" do it, because the assumption is that each of the securities in the portfolio has a lognormal terminal distribution, and the sum of lognormally distributed variables it not itself lognormally distributed. In theory one needs an N-dimensional tree (or grid) to treat an N-element portfolio.
I write "cannot" in quotes because this problem is actually quite commonly encountered and solved in one of a few ways, none of which involves a binomial tree:
The final technique is almost certainly what you want to use.