MOve up/down factor for binomial option pricing models

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KevPei

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In the 2012 morning mock question 9, they tell you a stock price can go up 15% and down 10%. This usually means the move up factor is u=1.15 and the move down factor is d=1/1.15=0.8696. however, the answer used 0.9 as the down factor. WTF. What knowledge am I missing?
 
And this also happend in the 2013 afternoon mock Q10, where move up was 15% and move down was 20%.. but u =1.15 however, d=0.8
 
Okay for Mock 2013, they give us that the probability of a down move is 20%, so 1-0.2 = 0.8
and I guess we can do the same for Mock 2012, since the down move is 10%, 1-0.1 = 0.9
 
What about when you need to find the cost of the option c0, so you multiply c+ by (1+RF-d)/(u-d)? I have done a Schweser mock where they simply multiply c+ and c- by the up/down factor. Should I assume this incorrect? And we should always find out the 1+RF blabla formula?
Thanks!
 
Sometimes the Mock will give you the percentage moves up or the probability moves in the problem. The analyst in the vignette probably determined these numbers from some method of professional judgment other than the risk neutral (i think thats the name for it) equations which we normally use in binomial option pricing models.
 
The formula (1+rf-d)/(u-d) is the probability of an up move, we should always calculate it if isn’t given to us and multiply it by c+ and multiply c- by the probability of the down move
The up move and down factor are only used to find the stock price at time =1. you multiply the stock price into the up/down factor.
 
El89 wrote:
The formula (1+rf-d)/(u-d) is the probability of an up move, we should always calculate it if isn’t given to us and multiply it by c+ and multiply c- by the probability of the down move
The up move and down factor are only used to find the stock price at time =1. you multiply the stock price into the up/down factor.
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just to clarify… factors is the 1+%U or 1-%D. so when solving for the probabilities. U = 1+%U and D = 1-%D . you DONT want to use U = 20% and D = -10% (or w/e is given.
 
Thank you all! It’s nice to get the confirmation. Good to point out RayJay, I made that mistake once so I surely won’t tomorrow! Best of luck.
 
I’m not even going to try and remeber the binomial model. I’ll let you know how it works out for me.
 
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