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This paper presents a simple discrete-time model for valuing options. 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 the celebrated Black-Scholes 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 construction, it gives rise to a simple and efficient numerical procedure for valuing options for which premature exercise may be optimal. Our best thanks go to William Sharpe, who first suggested to us the advantages of the discrete-time approach to option pricing developed here.

We are also grateful to our students over the past several years. Their favorable reactions to this way of presenting things encouraged us to write this article.

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EconPapers: Option pricing: A simplified approach

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Journal of Financial Economics Volume 7, Issue 3 , September , Pages Author links open the author workspace.

Massachusetts Institute of Technology, Cambridge, MA , USA Stanford University, Stanford, CA , USA. Yale University, New Haven, CT , USA.

University of California, Berkeley, CA , USA. Abstract This paper presents a simple discrete-time model for valuing options. Check if you have access through your login credentials or your institution.

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