Tag Info

Hot answers tagged brownian-motion

9

Baxter and Rennie say it better than me, so I will summarize them. Suppose that $N_t$ is not stochastic and $f(.)$ is a smooth function then the Taylor expansion is $$df(N_t) = f'(N_t)dN_t + \frac{1}{2}f''(N_t)(dN_t)^2 + \frac{1}{3!} f'''(N_t)(dN_t)^3 + \ldots$$ and the term $(dN_T)^2$ and higher terms are zero. Ito showed that this is not the case in the ...

9

The way you do it in the first place is a discretization of the Geometric Brownian Motion (GBM) process. This method is most useful when you want to compute the path between $S_0$ and $S_t$, i.e. you want to know all the intermediary points $S_i$ for $0 \leq i \leq t$. The second equation is a closed form solution for the GBM given $S_0$. A simple ...

9

One reference is "The Econometrics of Financial Markets" by John Y. Campbell, Andrew W. Lo, & A. Craig MacKinlay -- http://press.princeton.edu/TOCs/c5904.html. In particular: 9.3.1 Parameter Estimation of Asset Price Dynamics 356 9.3.4 The Effects of Asset Return Predictability 369 You might also take a look at Chan (1992) "An Empirical Comparison ...

8

Yes, you need Cholesky factorization. You can find the general idea here: http://www.goddardconsulting.ca/option-pricing-monte-carlo-basket.html Plus the implementation in MATLAB here: http://www.goddardconsulting.ca/matlab-monte-carlo-assetpaths-corr.html The code in general should be easily translatable. The only difficulty is the Cholesky factorization ...

6

I like Richard's answer, but I think we can compute the mean and the variance of $\int_0^T W_t dt$ by ourselves using Ito's lemma. Let $f(W_t, t) = t W_t$. $$d( t W_t ) = W_t dt + t dW_t .$$ Integrating both sides, and re-arranging the terms, we get $$\int_0^T W_t dt = T W_T - \int_0^T t dW_t \, .$$ We'll be using Ito's isometry formula $\mathbb{E} ... 6 The model for the stock is the Bachelier model with the solution $$S(t) = S(0) + \sigma W(t)$$ Thus the law of the stock$S(t)$is Gaussian with mean$S(0)$and variance$\sigma^2 t$. For average process$Z(T)$is thus the average of linear Brownian motion, we can rewrite this as $$Z(T) = \frac{1}{T} \int_0^T S(0) + \sigma W(t) dt = S(0) + ... 6 well, it is absolutely in agreement with theory. the correlation as measured by Pearson's coefficient \rho is linear measure in the sense that the bounds [-1,1] are obtained only when transformations of our variables are linear, so if we have variables X and Y then something like aX+bY+c where a,b\in\mathbb{R^*}, c\in\mathbb{R} will have ... 5 I would like to add a few more points to @Phun's already very good answer: The question is interesting because generalized Brownian motion already covers a lot of cases: This example includes all possible models of an asset price process that is always positive, has no jumps, and is driven by a single Brownian motion for each asset. (Shreve, ... 5 As you said, \mu is the expected return that is the expected value (mathematical expectation) of the random variable "stock return" under the objective probability measure. Assuming that returns are stationary*, the obvious way to estimate it is to compute a large number N of returns R_i, then to average them. You also want to annualize this average ... 5 For completeness, let's restate that the discrete case goes like this:$$\Delta S_t = S_{t+\Delta t}- S_t = \mu S_t \Delta t + \sigma \sqrt{\Delta t} Z_t $$with Z_t \sim \mathcal{N}(0,1). What you are doing in your case (although there is a typo in your formula) is to use the exact solution of the SDE to model the move between two points of S. ... 5 Martingales + Markovian Here is the motivation. Conditional expectations are martingales by the tower property of conditional expectations (an easy exercise to show). Suppose r=0, by the risk neutral pricing theorem E^\star\left[h(X_T)\bigg|\mathscr{F}_t,\,X_t=x\right] is the price of any derivative security with X as the underlying asset and payoff ... 4 So where to begin? Continuity is a big thing as it fails to take into account jumps, the Gaussian assumption is another big one. However, looking deeper into it stationarity is a huge problem as it applies to financial time series. However, it does an OK job at simulation stuff in the long-run. 4 The Feynman-Kac theorem primarily makes sense in a pricing context. If you know that some function solves the Feynman-Kac equation you can represent it's soluation as an Expectation with respect to the process. (confer this document) On the other hand a pricing function solves the FK-PDE. Thus often one would try solving the PDE to get a closed form ... 3 Maybe this could also be a comment but I think an it is not possible to answer this question with a 'yes and here is how you do it'. It has been tried, e.g. by me for a university research project. In this research we focused primarily on aggregation of returns and the main problem was the tractability of the resulting distributions and expressions, also ... 3 From this paper: The geometric Brownian motion model implies that the series of ﬁrst differences of the log prices must be uncorrelated. But for the S&P 500 as a whole, observed over several decades, daily from 1 July 1962 to 29 Dec 1995, there are in fact small but statistically signiﬁcant correlations in the differences of the logs at short time ... 3 Note: There is a typo in your third equations. Instead of S(u) it should be S(t_{i}) and in place of S(t) there should be S(t_{i+1}). In fact, given S(t_{i}) we have that$$S(t_{i+1}) = S(t_{i}) \exp\left( (\mu - \frac{1}{2} \sigma^2) (t_{i+1} - t_{i}) + \sigma (W(t_{i+1}) - W(t_{i})) \right)$$is the exact solution of the SDE. Hence, the ... 3 The way I think of it is that the PDE describes the flow of a time dependent probability distribution. The stochastic process describes individual realisations (random walks with a drift), but if you ran a large number of them you'd build up a distribution. The PDE says how that distribution changes in time (first term) due to deterministic drift (the ... 3 Question 2 has a straight forward solution using a differential equation approach: \mathbb{P}(\tau^\mu_a<\infty)=1 The following link (pp. 21 f.) explains it nicely (and is also very detailed) - could not write it much better. If you were to google "brownian motion linear boundary" you will get additional results. Also if you are generally interested ... 2 It depends on the frequency and the horizon. For instance, I got a similar looking chart when I used annual log returns as the input to the log normal distribution and went out 250 years. With daily log returns over a few years, there isn't nearly as much of a decay. However, when you go out 250 years with daily returns you still see the pattern. 2 I take it that μ is the drift of the long-term equilibrium price. let's take a lognormal model as an example, dS = μ x dt + σ x S x dz where: S= spot, t = time, T-t = length of time μ = drift rate, σ = volatility, dz= random variable, In order to solve for μ, you might first want to look for the expected spot price: given X = ln(S), dX = ((μ - ... 2 Its very simple, One of Brownian Motion (a.k.a. Wiener process in Mathematics) properties is that each increment from s->t is normally distributed with mean = 0 and sd = t-s. So, if the process that drives your simulated results is ~N(0, t-s) distributed for each increment s->t with 0<=s<=t then yes, your simulated draw downs should match the ones ... 2 Take a look at the following paper about the Maximum Drawdown distribution: On the Maximum Drawdown of a Brownian Motion The authors end up with an approximative series for the density. It is implemented in the function maxdd of the R-package fBasics. There are convenient functions dmaxdd, pmaxdd and rmaxdd. Calculating the Expected Drawdown should be ... 2 I think there is no mistake on your part, if you set sigma <- 0.0045 and x <- seq(100, 112, length=100) // Lower values produce jagged edges y <- seq(0.25, 1.1, length=60) you'll get this: With these parameters the density has about the same peak and the maximum of the density function also has a similar direction. Alas, a number of things are ... 2 There is of course no closed-form formula for this. However, the community has long since worked out what all the distributional moments are. A common use is to get the equivalent lognormal (or sometimes shifted lognormal) distribution to a portfolio (such as your difference). Here's a recent moments paper in which they go so far as to run a binomial tree ... 2 I dont know what you want to hear, but i have several points for you: The main driver of uncertainty is a Wiener process, which goes back to the discrete binomial model for stock prices. In reality the main stochastic source could be something completly different. \alpha and Vola \sigma are depending directly on your stockprice. Why should they? the ... 2 The consensus nowadays is that stable distributions are not a well fit, although they do possess heavy tails. In particular Cauchy has too fat tails. The reasons for this are disparate, however the first that comes to mind is that empirically longer horizons show a decrease in tail thickness, approaching normality for 1-year returns (although this has been ... 2 First, your statement that dW_t=\sigma\,dt^{1/2} is incorrect. In fact, it's not even meaningful (you can see this by noticing that the expression on the left-hand-side is an "increment" of Brownian motion, and hence random, while the expression on the right-hand side is deterministic). What you mean to say is that W is a Brownian motion, and hence ... 2 I don't know what you mean by "any scaling" rule. For the square-root of time I can say that it only needs uncorrelated returns. Assume that the return from time point 1 to T is called r_{1,T} and that it is given as r_{1,T} = r_1 + r_2 + \cdots + r_T = \sum_{t=1}^T r_t where r_t, t=1,\ldots,T are the one-period (e.g. one day) returns. The ... 2 You want to work directly with \overline{X}, and not some other r.v. with the same distribution, since equivalence in distribution doesn't imply that correlation remains the same. For ease of notation, I'll assume that \mu = 0 and \sigma = 1. I claim that$$ \text{cov}\left(\overline{X},X \right) = \frac{1}{t} \int_0^t s \ ds.$$Note that this is ... 1 I would calculate it this way,$⟨[W_s+W_t−2W_0]^2⟩=\mathbb{E}[(W_s+W_t−2W_0)^2]\\ \hspace{4cm}= \mathbb{E}[((W_s-W_0)+(W_t-W_0))^2]\\ \hspace{4cm}=\mathbb{E}[(W_s-W_0)^2]+\mathbb{E}[(W_t-W_0)^2]+2\mathbb{E}[(W_s-W_0)(W_t-W_0)] \\ \hspace{4cm}=s+t+2\mathbb{E}[W_sW_t]\\ \hspace{4cm}=s+t+2min(s,t)\$

Only top voted, non community-wiki answers of a minimum length are eligible