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THE RELATIONSHIP BETWEEN THE FINITE DIFFERENCE METHOD AND TRINOMIAL TREES LUCIA ŠVÁBOVÁ University of Žilina, Faculty of Operation and Economics of Transport and Communications, Department of Quantitative Methods and Economic Informatics, Univerzitná 1, 010 26 Žilina email: [email protected] MAREK ĎURICA University of Žilina, Faculty of Operation and Economics of Transport and Communications, Department of Quantitative Methods and Economic Informatics, Univerzitná 1, 010 26 Žilina email: [email protected] Abstract The paper deals with the relation of the Finite difference method to Trinomial Tree Approaches. The Finite difference method is numerical method which can be used for pricing many types of options. This is very useful especially in some cases of exotic options for which the analytical formula does not exist. But in some cases there could appear some inconsistencies of the results of options prices determined by this method. The Explicit finite difference method is equivalent to the Trinomial tree approach. Using the expression of the probabilities of moving the stock price in the Trinomial tree to the explicit version of Finite difference method can be explained this main problem associated with this method Key words: finite difference method, trinomial tree, option pricing.
