Lookback Option Valuation

Abstract

The binomial model is a simple and straightforward way to price simple and straightforward options, like plain vanilla calls and puts, even with American exercise. But path-dependent contracts, such as lookback options, present problems for the binomial because of the need to keep track of a path statistic, in this case, the highest or lowest price attained, along each path through the lattice. Choi and Jameson present a very clever technique for stepping backward through the tree much more efficiently, so that one can value a lookback without carrying an auxiliary variable.