Willow Power: Optimizing Derivative Pricing Trees

A new type of recombining derivative pricing tree is presented as an alternative to standard binomial and trinomial trees. This tree, called the “Willow” tree, expands as the square root of time and therefore avoids the unnecessary computations that are performed in the “wings” of standard binomial and trinomial trees. It is shown that arranging the tree in accordance with the process being modeled gives dramatic improvements in computational efficiency.