# Tag Info

6

Shreve's theorem also called "Girsanov II" indeed represents a special case of the general "Girsanov I" from Wiki above, with $$Y_t:=W_t,$$$$X_t:=-\int_0^t\Theta_udW_u$$ We can show: $$[Y,X]=-\int_0^t\Theta_udu$$ by using general Stochastic Calculus rules (e.g. p.37, 6.6 here): ...

5

It depends on the purpose of your simulation. If you want to model the asset price path for pricing some derivative then you need the risk-neutral measure (thus you take the risk-less rate as drift). Why? Because the risk-neutral measure makes your pricing compatible with the pricing of other contracts in the market. It makes the prices consistent. If ...

4

It doesn't imply $$\ln S_T=\ln S_0+rT+σW^Q_T,$$ it implies $$\ln S_T=\ln S_0+(r-0.5\sigma^2)T+σW^Q_T.$$ Look up Ito's lemma. This is covered in just about any book on financial maths including my own Concepts etc.

4

Bond Price Dynamics I do not know the source of the bond dynamics you show above but seeing how we are dealing with an affine model there is a very elegant way to derive those. Due to the model being affine the bond price is given by $$P(t,T)=A(t,T)e^{-r(t)B(t,T)}$$ you can find the exact formulas for $A(t,T)$ and $B(t,T)$ in this document (or just read ...

3

Your notations are really hard to follow as you define $\mathbb{P}$ twice at the beginning. The notation $\mathbb{P} = \mathbb{\hat{P}}$ and $\mathbb{P} =\mathbb{\tilde{P}}$ is not meaningful as the probability measure $\mathbb{P}$ is already fixed and used for the real world probability measure. I think that this is the reason why you are getting confused. ...

3

Your mistake is actually made at the beginning: "Introducing a new process: $d\tilde{W}_t = dW_t +\frac{\mu-r}{\sigma} dt$" This is incorrect. Rather, $d\tilde{W}_t = dW_t -\frac{\mu-r}{\sigma} dt$ Otherwise, your derivation is correct. After correcting for the sign error, your final equation becomes $\Phi(x)=e^{-\lambda x-\frac{1}{2}\lambda^2 t}$. ...

1

A martingale must have constant expectation, such that adding a deterministic finite variation process $(b-r)dt$ would break the martingale property (except for when its a constant, which it is not by multiplication with $dt$). Hence the finite variation process must be eliminated under $Q$ for LRS to be an (equivalent) martingale measure, and as shown the ...

1

I saw a quote from Brigo & Mercurio "IR models" (page 26, 2.1 No-Arbitrage in Continuous Time) . May be it will help you to find answer: Harrison and Pliska (1983) proved the following fundamental result. A financial market is (arbitrage free and) complete if and only if there exists a unique equivalent martingale measure.

1

The error is in the application of Girsanov theorem. We have multivariate Black-Sholes market, however I apply one-dimensional Girsanov theorem. I should apply multi-dimensional Girsanov theorem. Then there would be now such equations, except the case for $\rho=1$. The alike task is formulated here ...

1

If $dS_t = r S_t \, dt + \sigma S_t \, dW_t^Q$, $$S_T = S_0 \, e^{\sigma W_T^Q + \left( r - \frac{1}{2} \sigma^2\right) T}\, .$$ Hence $\mathbb{E}\left[ S_T \right] = S_0 \, e^{rT} \,.$

1

Note that $$\frac{dQ_{T_p}}{dQ}|_{T_0} = \frac{P(T_0, T_p)}{P(0, T_p)}\frac{A(0, T_0, T_n)}{A(T_0, T_0, T_n)}$$. Then $$E^{Q_{T_p}}\big(S(T_0, T_n)\big) = E^Q\bigg(S(T_0, T_n) \frac{P(T_0, T_p)}{P(0, T_p)}\frac{A(0, T_0, T_n)}{A(T_0, T_0, T_n)}\bigg) \\ = \frac{A(0, T_0, T_n)}{P(0, T_p)} E^Q\bigg(S(T_0, T_n) \frac{P(T_0, T_p)}{A(T_0, T_0, T_n)}\bigg).$$ That ...

1

No, that's the point of Girsanov's theorem. If $Q$ is equal to $P_1$, then nothing has changed. In order to make $B_1(t)$ a standard BM we need to transition to a new Law. Namely, $Q$.

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