What is the interpolation method used in the BDTPRICE function in the Financial Derivatives Toolbox 3.0.1 (R14SP1) when the cash flow date falls between two tree nodes?

I have a cash flow date that falls between two tree nodes and I would like to know what interpolation method the BDTPRICE function is using in this case.

Answer 1

[MathWorks Support Team]

When the cash flow date falls between tree levels, the interpolation method (refer to page A-3 of the Financial Derevative Toolbox) depends on the input argument "options", generated with the DERIVSET function.

When the parameter "ConstRate" is set to "On", which is the default case, the rate between nodes is assumed to be constant between the tree levels. In this case no interpolation is done. This is not an arbitrage free assumption, and therefore the result will be approximate.

When the parameter "ConstRate" is set to "Off", a new tree will be generated such that there is a tree level in all cash flow dates, and the result will be arbitrage free.