I was reading about the Gaussian shift theorem in "An Introduction to Exotic Option Pricing" by Peter Buchen and came across a question that I can't seem to figure. In the book, he uses F(Z) (a measurable scalar function of Z, Z being Gaussian rv with a normal variate) but the function doesn't appear in the question and rather just uses Z1 and Z2.

enter image description here

where 1D is the univariate Gaussian distribution and GST is the Gaussian shift theorem

Any help would be much appreciated.


The Gaussian Shift Theorem says that, for a standard Gaussian random variable $Z$, constant $c$, and function $F$, we have the expectation \begin{align*} E\left(e^{cZ} F(Z) \right) = e^{\frac{1}{2} c^2}E\big(F(Z+c) \big). \end{align*} Given the decomposition of $Z_2=\rho Z_1 + \sqrt{1-\rho^2} Z$, where $Z$ is independent of $Z_1$, \begin{align*} E\left(Z_1 e^{a Z_2} \right) &= E\left(Z_1 e^{a \rho Z_1 + a \sqrt{1-\rho^2}Z } \right)\\ &=E\left(Z_1 e^{a \rho Z_1}\right) E\left(e^{a \sqrt{1-\rho^2}Z } \right). \end{align*} Now, you can apply the Gaussian Shift Theorem to compute each of them.

  • $\begingroup$ My attempt gave me: e^(0.5a^2)E(Z1+aρ)e^(0.5(a^2-a^2ρ^2))E(a√(1−ρ^2) +Z) = a^2e^(0.5a^2) Should E(a√(1−ρ^2) +Z) not have been there to begin with if E(e^(a√(1−ρ^2)Z)) is treated as the expectation of a constant? $\endgroup$ – user385728946 Sep 9 '18 at 12:51
  • $\begingroup$ My bad, my attempt gave me √(1−ρ^2)a^2pe^(0.5a^2) not a^2e^(0.5a^2), and that I assumed E(Z1) and E(Z) would both equal 1 if they follow the Gaussian distribution. $\endgroup$ – user385728946 Sep 9 '18 at 13:33
  • $\begingroup$ assuming $c= a \rho$, for the first one, and $a=a\sqrt{1-\rho^2}$, for the second one. $\endgroup$ – Gordon Sep 9 '18 at 13:55
  • $\begingroup$ I'm afraid I don't completely follow. $\endgroup$ – user385728946 Sep 12 '18 at 5:37

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.