Modeling Generic Mean Reversion Processes with a Symmetrical Binomial Lattice - Applications to Real Options

AbstractIn this paper we propose a Symmetrical Binomial Lattice Approach that is equivalent to the well-known and widely utilized Lattice of Cox, Ross & Rubinstein when modeling Geometric Brownian Motion type of processes, but can be utilized for a wide variety of other Markov style stochastic processes, such as Mean Reversion. This is due to the highly intuitive construction in which first the expected value expression of the process is directly used and the variance is modeled in a symmetrical lattice, which is added to the first. We then demonstrate its applicability with several Real Options examples, comparing to the Cox et al model