Option pricing for the transformed‐binomial class

This article generalizes the seminal Cox‐Ross‐Rubinstein (1979) binomial option pricing model to all members of the class of transformed‐binomial pricing processes. The investigation addresses issues related with asset pricing modeling, hedging strategies, and option pricing. Formulas are derived for (a) replicating or hedging portfolios, (b) risk‐neutral transformed‐binomial probabilities, (c) limiting transformed‐normal distributions, and (d) the value of contingent claims, including limiting analytical option pricing equations. The properties of the transformed‐binomial class of asset pricing processes are also studied. The results of the article are illustrated with several examples. © 2006 Wiley Periodicals, Inc. Jrl. Fut Mark 26:759–787, 2006