A q-binomial extension of the CRR asset pricing model

Abstract

We propose an extension of the Cox-Ross-Rubinstein (CRR) model based on q-binomial (or Kemp) random walks, with application to default with logistic failure rates. This model allows us to consider time-dependent switching probabilities varying according to a trend parameter on a non-self-similar binomial tree. In particular, it includes tilt and stretch parameters that control increment sizes. Option pricing formulas are written using q-binomial coefficients, and we study the convergence of this model to a Black-Scholes type formula in continuous time. A convergence rate of order is obtained.