P1.T2. 316.3 Discrete Distribution (Bin Tree) Quetsion

[MissJaguar]

To me it seems that the answer to question 316.3 provided in materials (15.824%) is totally wrong.

In a 12 - step-binomial tree there are 144 ( 12 power 2) states of nature at the end of the last step, with 13 different payoffs (12 +1). Moreover, there are 2 states of nature that can yield the same result as in the very beginning (USD 100), each with the probability (p^6) * ((1-p)^6) that is (0.62 ^ 6 )*(0.38^6). Thus 15.8 % is simply too large probability that cannot be the correct result.

Thanks for your feedback + Good luck!

 

[David Harper CFA FRM]

Hi @MissJaguar I think it's correct, we need to multiply (0.62 ^ 6 )*(0.38^6), which is the probability of an exact sequence (a permutation) of 6 up and 6 down, by C(12,6), which is the number of different combinations (paths), see https://forum.bionicturtle.com/thre...e-distributions-topic-review.7221/#post-27919