Modified Binomial Tree and Market Efficiency: The Case for KLCI and LTCM

The traditional Monte Carlo simulation and binomial tree algorithms based upon the Black-Scholes world are modified to include a growth term to incorporate an irrational market return, a concept ignored in the basic price framework of Black-Scholes-Merton. This modified algorithm is applied to the Kuala Lumpur Composite Index KLCI and Public Aggressive Growth Fund PAGF between June 2006 and September 2008 to factor in the irrational behavior of the market. The implications are that irrational market behavior often distorts market values, which will eventually return to normal, with the corollary that the market is currently near the bottom.