Final answer:
The binomial process is a simplified model representing stock price movements for computational purposes, based on the premise that stock prices either go up or down. It provides a framework for understanding binomial experiments and option pricing despite the market's unpredictability.
Step-by-step explanation:
The binomial process is a simplified representation of stock price movements used in the binomial model of option pricing. Despite stock prices following what can be considered a "random walk with a trend" due to the unpredictable nature of future news affecting profits, the binomial process serves as a reasonable approximation for educational and computational purposes. In the binomial model, the stock price at any future point in time can move to one of two possible prices, representing the outcomes of success (price up) or failure (price down).
We study the binomial model because binomial experiments fit well into a binomial probability distribution, making it easier to analyze and predict the outcomes. The model provides a framework for understanding option pricing and helps economists to establish a predictable pattern over short intervals, despite the inherent unpredictability of the market. It simplifies complex market movements into two possible states, allowing easier computations of probabilities and option pricing.