Lattice model (finance)

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In finance, a lattice model can be used to find the fair value of a stock option. The model divides time between now and the option's expiration into N discrete periods. At the specific time n, the model has an infinite number of outcomes at time n + 1 such that every possible change in the state of the world between n and n + 1 is captured in a branch. This process is iterated until every possible path between n = 0 and n = N is mapped. Probabilities are then estimated for every n to n + 1 path. The outcomes and probabilities flow backwards through the tree until a fair value of the option today is calculated. A simple lattice model for options is the binomial options pricing model.