Binomial Trees and Factor Models

Free CAIA Level II lesson in Methods and Models. 37 min read, ~5,613 words.

Binomial trees price up/down moves under Q-measure (risk-neutral) probabilities; a P-measure is a real, unbiased statistical probability, a Q-measure is a biased quasi-probability assumed under risk-neutrality. The risk-neutral up probability is, valid whenever d < 1 + r < u; never substitute the real-world chance of an up move. A...

What this lesson covers

• Content
• Example 1
• Example 2
• Common Mistakes
• Check Your Understanding
• Exam Shortcuts

Learning objectives

• model types
• fi models intro
• bdt model
• credit risk economics
• structural model overview
• merton model
• kmv model
• reduced form models
• empirical credit models
• one period binomial
• multi period binomial
• tree prices formation
• convertible valuation
• callable bonds tree
• multifactor asset pricing
• fama french
• empirical mf challenges
• factor investing
• adaptive markets
• efficiently inefficient
• trend following
• divergence
• fundamental directional
• behavioral finance
• directional factors
• digital asset valuation
• pca statistical factors
• multifactor regression
• partial autocorrelations
• dynamic risk exposure
• changing correlation
• multifactor return approaches
• performance persistence
• rv overview
• statistical pairs equities
• pairs commodity spreads
• pairs rates fx
• rv market neutral risks
• depreciation tax shields
• tax deferral gains
• after tax comparisons
• transaction based indices
• appraisal based indices

Browse all free CAIA Level II lessons or jump into free CAIA Level II practice questions.