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I am having some trouble setting up a replicating strategy for a call option with a three step binomial model (discrete).

I have no trouble doing this in a two step binomial model by backward recursion on time.

Any guidance on how to do this with a three step binomial model (discrete)?

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  • $\begingroup$ Do you mean 3 or 2 periods? A 2-period model has 3 steps. $\endgroup$ – emcor Jun 14 '15 at 21:50
  • $\begingroup$ Where exactly do you have trouble? If I get your described correct you find that you have to solve a linear equation with two unknowns but three equations? Is this correct? $\endgroup$ – muffin1974 Jun 14 '15 at 22:35
  • $\begingroup$ Thank you. I think I understand. Just like with two steps but one more equation. $\endgroup$ – Optimus257 Jun 15 '15 at 8:09

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