Implied Trinomial Trees and Their Implementation with XploRe

The software XploRe offers many nice tools for modelling implied trinomial trees (ITT’s). ITT is an option pricing technique which tries to fit the market volatility smile. It uses an inductive algorithm constructing a possible evolution process of underlying prices from the current market option data. At each stage the price of the underlying can move to three different positions. Firstly, we describe the construction of ITT’s as described in Derman, Kani & Chriss (1996), and then we show their implementation in XploRe and explain the computing and plotting macros thoroughly. Copyright Physica-Verlag 2003