OPTION PRICING: A SIMPLIFIED APPROACH

John C. COX
Massachusetts Institute of Technology, Cambridge, MA 02139, USA
Stanford University, Stanford, CA 94305, USA
Stephen A. ROSS
Yale University, New Haven, CT06520, USA
Mark RUBINSTEIN
University of Califorma, Berkeley, CA 94720, USA

Received March 1979, revised version received July 1979


This paper presents a simple discrete-time model for valumg optlons. The fundamental economic principles of option pricing by arbitrage methods are particularly clear In this setting. Its development requires only elementary mathematics, yet it contains as a special limiting case thecelebrated Black-&holes model, which has previously been derived only by much more difficult methods. The basic model readily lends itself to generalization in many ways. Moreover, by its very constructlon, it gives rise to a simple and efficient numerical procedure for valumg optlons for which premature exercise may be optimal.