The network of lines and nodes which is laid out in the establishment of a binomial or trinomial option pricing model, aiming to figure out the prices of path-dependent options.
Lattice models are option-pricing models that involve the setting up of a binomial or trinomial tree representing a range of paths that might be followed by the underlying asset during the option’s life. The fair value of the option is then calculated by backward induction through the lattice. These models valuate options by dividing time into discrete bits and model prices at different nodes. The lattice covers a period of time which is broken down into manageable time periods (month, quarter, semi-annual, or annual), so that the model can predict possible prices at each node (i.e. at the end of each time period).
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