Binomial Trees and Factor Models
Free CAIA Level II lesson in Methods and Models. 37 min read, ~5,536 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. A one-period defaultable bond prices at the probability of nondefault; once a risk premium enters, the credit spread cannot separate default probability from risk-aversion...
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What this lesson covers
- Content
- Example 1
- Example 2
- Common Mistakes
- Key Takeaways
- 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
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