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A (µ, σ) Brownian motion is the limiting case of random walk

在文檔中 Currency Swaps (頁 50-89)

Brownian Motion as Limit of Random Walk

Claim 1 A (µ, σ) Brownian motion is the limiting case of

Brownian Motion as Limit of Random Walk (continued)

• (continued) – Here

Xi



+1 if the ith move is to the right,

−1 if the ith move is to the left.

– Xi are independent with

Prob[ Xi = 1 ] = p = 1 − Prob[ Xi = −1 ].

• Recall E[ Xi ] = 2p − 1 and Var[ Xi ] = 1 − (2p − 1)2.

Brownian Motion as Limit of Random Walk (continued)

• Therefore,

E[ Y (t) ] = n(∆x)(2p − 1), Var[ Y (t) ] = n(∆x)2 [

1 − (2p − 1)2 ] .

• With ∆x ≡ σ√

∆t and p ≡ [ 1 + (µ/σ)√

∆t ]/2, E[ Y (t) ] = nσ√

∆t (µ/σ)√

∆t = µt, Var[ Y (t) ] = 2∆t [

1 − (µ/σ)2∆t]

→ σ2t, as ∆t → 0.

Brownian Motion as Limit of Random Walk (concluded)

• Thus, { Y (t), t ≥ 0 } converges to a (µ, σ) Brownian motion by the central limit theorem.

• Brownian motion with zero drift is the limiting case of symmetric random walk by choosing µ = 0.

• Note that

Var[ Y (t + ∆t) − Y (t) ]

=Var[ ∆x Xn+1 ] = (∆x)2 × Var[ Xn+1 ] → σ2∆t.

• Similarity to the the BOPM: The p is identical to the probability in Eq. (27) on p. 256 and ∆x = ln u.

Geometric Brownian Motion

• Let X ≡ { X(t), t ≥ 0 } be a Brownian motion process.

• The process

{ Y (t) ≡ eX(t), t ≥ 0 }, is called geometric Brownian motion.

• Suppose further that X is a (µ, σ) Brownian motion.

• X(t) ∼ N(µt, σ2t) with moment generating function E

[

esX(t) ]

= E [ Y (t)s ] = eµts+(σ2ts2/2) from Eq. (20) on p 148.

Geometric Brownian Motion (continued)

• In particular,

E[ Y (t) ] = eµt+(σ2t/2), Var[ Y (t) ] = E [

Y (t)2 ]

− E[ Y (t) ]2

= e2µt+σ2t (

eσ2t − 1) .

0.2 0.4 0.6 0.8 1 Time (t) -1

1 2 3 4 5 6 Y(t)

Geometric Brownian Motion (continued)

• It is useful for situations in which percentage changes are independent and identically distributed.

• Let Yn denote the stock price at time n and Y0 = 1.

• Assume relative returns

Xi Yi Yi−1

are independent and identically distributed.

Geometric Brownian Motion (concluded)

• Then

ln Yn =

n i=1

ln Xi

is a sum of independent, identically distributed random variables.

• Thus { ln Yn, n ≥ 0 } is approximately Brownian motion.

– And { Yn, n ≥ 0 } is approximately geometric Brownian motion.

Continuous-Time Financial Mathematics

A proof is that which convinces a reasonable man;

a rigorous proof is that which convinces an unreasonable man.

— Mark Kac (1914–1984) The pursuit of mathematics is a divine madness of the human spirit.

— Alfred North Whitehead (1861–1947), Science and the Modern World

Stochastic Integrals

• Use W ≡ { W (t), t ≥ 0 } to denote the Wiener process.

• The goal is to develop integrals of X from a class of stochastic processes,a

It(X)

t 0

X dW, t ≥ 0.

• It(X) is a random variable called the stochastic integral of X with respect to W .

• The stochastic process { It(X), t ≥ 0 } will be denoted by ∫

X dW .

aKiyoshi Ito (1915–2008).

Stochastic Integrals (concluded)

• Typical requirements for X in financial applications are:

– Prob[t

0 X2(s) ds < ∞ ] = 1 for all t ≥ 0 or the stronger ∫ t

0 E[ X2(s) ] ds < ∞.

– The information set at time t includes the history of X and W up to that point in time.

– But it contains nothing about the evolution of X or W after t (nonanticipating, so to speak).

– The future cannot influence the present.

• { X(s), 0 ≤ s ≤ t } is independent of { W (t + u) − W (t), u > 0 }.

Ito Integral

• A theory of stochastic integration.

• As with calculus, it starts with step functions.

• A stochastic process { X(t) } is simple if there exist 0 = t0 < t1 < · · · such that

X(t) = X(tk−1) for t ∈ [ tk−1, tk), k = 1, 2, . . . for any realization (see figure on next page).

t0 t

1 t

2 t

3 t

4 t

5

X t

a f

t

Ito Integral (continued)

• The Ito integral of a simple process is defined as It(X)

n−1 k=0

X(tk)[ W (tk+1) − W (tk) ], (50) where tn = t.

– The integrand X is evaluated at tk, not tk+1.

• Define the Ito integral of more general processes as a limiting random variable of the Ito integral of simple stochastic processes.

Ito Integral (continued)

• Let X = { X(t), t ≥ 0 } be a general stochastic process.

• Then there exists a random variable It(X), unique almost certainly, such that It(Xn) converges in probability to It(X) for each sequence of simple

stochastic processes X1, X2, . . . such that Xn converges in probability to X.

• If X is continuous with probability one, then It(Xn) converges in probability to It(X) as

δn ≡ max1≤k≤n(tk − tk−1) goes to zero.

Ito Integral (concluded)

• It is a fundamental fact that

X dW is continuous almost surely.

• The following theorem says the Ito integral is a martingale.

– A corollary is the mean value formula

E

[ ∫ b a

X dW ]

= 0.

Theorem 17 The Ito integral

X dW is a martingale.

Discrete Approximation

• Recall Eq. (50) on p. 489.

• The following simple stochastic process { bX(t) } can be used in place of X to approximate the stochastic

integral ∫t

0 X dW ,

X(s)b ≡ X(tk−1) for s ∈ [ tk−1, tk), k = 1, 2, . . . , n.

• Note the nonanticipating feature of bX.

– The information up to time s,

{ bX(t), W (t), 0 ≤ t ≤ s },

cannot determine the future evolution of X or W .

Discrete Approximation (concluded)

• Suppose we defined the stochastic integral as

n−1 k=0

X(tk+1)[ W (tk+1) − W (tk) ].

• Then we would be using the following different simple stochastic process in the approximation,

Y (s)b ≡ X(tk) for s ∈ [ tk−1, tk), k = 1, 2, . . . , n.

• This clearly anticipates the future evolution of X.a

aSee Exercise 14.1.2 of the textbook for an example where it matters.

X

t

X

t

$ Y

(a) (b)

$X

Ito Process

• The stochastic process X = { Xt, t ≥ 0 } that solves Xt = X0 +

t 0

a(Xs, s) ds +

t 0

b(Xs, s) dWs, t ≥ 0 is called an Ito process.

– X0 is a scalar starting point.

{ a(Xt, t) : t ≥ 0 } and { b(Xt, t) : t ≥ 0 } are stochastic processes satisfying certain regularity conditions.

• a(Xt, t): the drift.

• b(Xt, t): the diffusion.

Ito Process (continued)

• A shorthanda is the following stochastic differential equation for the Ito differential dXt,

dXt = a(Xt, t) dt + b(Xt, t) dWt. (51) – Or simply

dXt = at dt + bt dWt.

– This is Brownian motion with an instantaneous drift at and an instantaneous variance b2t.

• X is a martingale if at = 0 (Theorem 17 on p. 491).

aPaul Langevin (1904).

Ito Process (concluded)

• dW is normally distributed with mean zero and variance dt.

• An equivalent form of Eq. (51) is dXt = at dt + bt

dt ξ, (52)

where ξ ∼ N(0, 1).

Euler Approximation

• The following approximation follows from Eq. (52), X(tb n+1)

= bX(tn) + a( bX(tn), tn) ∆t + b( bX(tn), tn) ∆W (tn),

(53) where tn ≡ n∆t.

• It is called the Euler or Euler-Maruyama method.

• Recall that ∆W (tn) should be interpreted as W (tn+1) − W (tn), not W (tn) − W (tn−1).

• Under mild conditions, bX(tn) converges to X(tn).

More Discrete Approximations

• Under fairly loose regularity conditions, Eq. (53) on p. 498 can be replaced by

X(tb n+1)

= bX(tn) + a( bX(tn), tn) ∆t + b( bX(tn), tn)

∆t Y (tn).

– Y (t0), Y (t1), . . . are independent and identically distributed with zero mean and unit variance.

More Discrete Approximations (concluded)

• An even simpler discrete approximation scheme:

X(tb n+1)

= bX(tn) + a( bX(tn), tn) ∆t + b( bX(tn), tn)

∆t ξ.

– Prob[ ξ = 1 ] = Prob[ ξ = −1 ] = 1/2.

– Note that E[ ξ ] = 0 and Var[ ξ ] = 1.

• This is a binomial model.

• As ∆t goes to zero, bX converges to X.

Trading and the Ito Integral

• Consider an Ito process dSt = µt dt + σt dWt. – St is the vector of security prices at time t.

• Let ϕt be a trading strategy denoting the quantity of each type of security held at time t.

– Hence the stochastic process ϕtSt is the value of the portfolio ϕt at time t.

• ϕt dSt ≡ ϕtt dt + σt dWt) represents the change in the value from security price changes occurring at time t.

Trading and the Ito Integral (concluded)

• The equivalent Ito integral, GT(ϕ)

T 0

ϕt dSt =

T 0

ϕtµt dt +

T 0

ϕtσt dWt, measures the gains realized by the trading strategy over the period [ 0, T ].

Ito’s Lemma

A smooth function of an Ito process is itself an Ito process.

Theorem 18 Suppose f : R → R is twice continuously differentiable and dX = at dt + bt dW . Then f (X) is the Ito process,

f (Xt)

= f (X0) +

t 0

f(Xs) as ds +

t 0

f(Xs) bs dW +1

2

t 0

f′′(Xs) b2s ds for t ≥ 0.

Ito’s Lemma (continued)

• In differential form, Ito’s lemma becomes df (X) = f(X) a dt + f(X) b dW + 1

2 f′′(X) b2 dt.

(54)

• Compared with calculus, the interesting part is the third term on the right-hand side.

• A convenient formulation of Ito’s lemma is df (X) = f(X) dX + 1

2 f′′(X)(dX)2.

Ito’s Lemma (continued)

• We are supposed to multiply out

(dX)2 = (a dt + b dW )2 symbolically according to

× dW dt

dW dt 0

dt 0 0

– The (dW )2 = dt entry is justified by a known result.

• Hence (dX)2 = (a dt + b dW )2 = b2 dt.

• This form is easy to remember because of its similarity to the Taylor expansion.

Ito’s Lemma (continued)

Theorem 19 (Higher-Dimensional Ito’s Lemma) Let W1, W2, . . . , Wn be independent Wiener processes and

X ≡ (X1, X2, . . . , Xm) be a vector process. Suppose

f : Rm → R is twice continuously differentiable and Xi is an Ito process with dXi = ai dt +n

j=1 bij dWj. Then df (X) is an Ito process with the differential,

df (X) =

m i=1

fi(X) dXi + 1 2

m i=1

m k=1

fik(X) dXi dXk, where fi ≡ ∂f/∂Xi and fik ≡ ∂2f /∂Xi∂Xk.

Ito’s Lemma (continued)

• The multiplication table for Theorem 19 is

× dWi dt

dWk δik dt 0

dt 0 0

in which

δik =



1 if i = k, 0 otherwise.

Ito’s Lemma (continued)

• In applying the higher-dimensional Ito’s lemma, usually one of the variables, say X1, is time t and dX1 = dt.

• In this case, b1j = 0 for all j and a1 = 1.

• As an example, let

dXt = at dt + bt dWt.

• Consider the process f(Xt, t).

Ito’s Lemma (continued)

• Then

df = ∂f

∂Xt dXt + ∂f

∂t dt + 1 2

2f

∂Xt2 (dXt)2

= ∂f

∂Xt (at dt + bt dWt) + ∂f

∂t dt +1

2

2f

∂Xt2 (at dt + bt dWt)2

=

( ∂f

∂Xt at + ∂f

∂t + 1 2

2f

∂Xt2 b2t )

dt + ∂f

∂Xt bt dWt. (55)

Ito’s Lemma (continued)

Theorem 20 (Alternative Ito’s Lemma) Let W1, W2, . . . , Wm be Wiener processes and

X ≡ (X1, X2, . . . , Xm) be a vector process. Suppose

f : Rm → R is twice continuously differentiable and Xi is an Ito process with dXi = ai dt + bi dWi. Then df (X) is the following Ito process,

df (X) =

m i=1

fi(X) dXi + 1 2

m i=1

m k=1

fik(X) dXi dXk.

Ito’s Lemma (concluded)

• The multiplication table for Theorem 20 is

× dWi dt

dWk ρik dt 0

dt 0 0

• Above, ρik denotes the correlation between dWi and dWk.

Geometric Brownian Motion

• Consider geometric Brownian motion Y (t) ≡ eX(t) – X(t) is a (µ, σ) Brownian motion.

– Hence dX = µ dt + σ dW by Eq. (49) on p. 473.

• As ∂Y/∂X = Y and ∂2Y /∂X2 = Y , Ito’s formula (54) on p. 504 implies

dY = Y dX + (1/2) Y (dX)2

= Y (µ dt + σ dW ) + (1/2) Y (µ dt + σ dW )2

= Y (µ dt + σ dW ) + (1/2) Y σ2 dt.

在文檔中 Currency Swaps (頁 50-89)

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