@article {Guo54, author = {Shuxin Guo and Qiang Liu}, title = {A Simple Accurate Binomial Tree for Pricing Options on Stocks with Known Dollar Dividends}, volume = {26}, number = {4}, pages = {54--70}, year = {2019}, doi = {10.3905/jod.2019.26.4.054}, publisher = {Institutional Investor Journals Umbrella}, abstract = {Known discrete dollar dividends lead to non-recombining binomial trees (NR-BT) with an explosion of nodes, and make the pricing of options much more complex. This article proposes a novel method for constructing a recombining binomial tree via balanced dividend adjustments (BDA). BDA is proved to converge to NR-BT for European options. Furthermore, BDA is shown heuristically to approximate NR-BT superbly for American options; for American calls, an error formula for BDA is derived and can be used to reduce further the pricing error. In a numerical illustration for American options, BDA turns out to be quite accurate, outperforming several existing approaches. A new insight emerges that BDA can be a competitive, yet simple, alternative to the industry practice of interpolating for dividends under binomial-tree or finite difference.TOPICS: Options, statistical methods, performance measurement}, issn = {1074-1240}, URL = {https://jod.pm-research.com/content/26/4/54}, eprint = {https://jod.pm-research.com/content/26/4/54.full.pdf}, journal = {The Journal of Derivatives} }