TY - JOUR T1 - A Simple Accurate Binomial Tree for Pricing Options on Stocks with Known Dollar Dividends JF - The Journal of Derivatives SP - 54 LP - 70 DO - 10.3905/jod.2019.26.4.054 VL - 26 IS - 4 AU - Shuxin Guo AU - Qiang Liu Y1 - 2019/05/31 UR - https://pm-research.com/content/26/4/54.abstract N2 - Known discrete dollar dividends lead to non-recombining binomial trees (NR-BT) with an explosion of nodes, and make the pricing of options much more complex. This article proposes a novel method for constructing a recombining binomial tree via balanced dividend adjustments (BDA). BDA is proved to converge to NR-BT for European options. Furthermore, BDA is shown heuristically to approximate NR-BT superbly for American options; for American calls, an error formula for BDA is derived and can be used to reduce further the pricing error. In a numerical illustration for American options, BDA turns out to be quite accurate, outperforming several existing approaches. A new insight emerges that BDA can be a competitive, yet simple, alternative to the industry practice of interpolating for dividends under binomial-tree or finite difference.TOPICS: Options, statistical methods, performance measurement ER -