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Questions tagged [martingale]

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4
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1answer
49 views

Discounted asset price is martingale in BS model

I want to verify that the discounted stock price process $\mathrm{e}^{-r(T-t)}V(S_t,t)$ is a martingale in the BS-model. Using Ito's formula and the BS-PDE I get that $$ \mathrm{d}\mathrm{e}^{-r(T-t)}...
0
votes
1answer
34 views

Risk neutrality coherence with risk aversion

I haven't been able to find an understandable explanation why the risk neutrality is coherent with the risk aversion implication of the expected utility hypothesis. I can see that when using the risk ...
3
votes
0answers
80 views

How to justify the martingale condition

By Radon-Nikodym theorem, the conditional expectation of $X$ with respect to a $\sigma$-algebra $\mathscr F$ is a nonnegative random variable denoted by $\def\E{\mathbf E}\E(X\mid \mathscr F)$, such ...
3
votes
1answer
78 views

Hedging Value-Financial Mathematics

EXERCISE We consider a free from arbitrage financial market $(Ω,F,P,S_0,S_1)$ with $α<S_0^{1}\cdot(1+r)<β$,where $$0<α:=min_{ω \in Ω} S_1^{1}(ω), β:=max_{ω \in Ω}S_1^{1}, α<β$$ Let ...
2
votes
1answer
72 views

Equivalent martingale measure exists if and only if $a < S_0^1(1+r)< b$

Exercise : We consider a market of one period $(\Omega, \mathcal{F}, \mathbb P, S^0, S^1)$, where the sample space $\Omega$ has a finite number of elements and the $\sigma-$algebra $\mathcal{F} = 2^...
2
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1answer
91 views

Showing that a market model has arbitrage and describing martingales

This is an exercise which I came upon while studying an introduction to financial mathematics. Exercise : Consider the finite sample space $\Omega = \{\omega_1,\omega_2,\omega_3\}$ and let $\...
4
votes
1answer
114 views

Change of numeraire between T-forward and Bank Account

I follow a course, and get to the point that one bond price discounted by another one is a martingale: $$ \frac{P(t,T_0)}{P(t,T_1)} - \text{ is a } \mathbb{Q}^{T_1} \text{ martingale } $$ I can not ...
3
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1answer
120 views

Libor Market Model (LMM) under risk neutral measure

I would like to establish the equations of forward libors under risk neutral measure. Here is how I do it, and what I get : Under the $P_{T_j} $ measure, forward Libor $L_j$ is martingale. Thus: $$ ...
0
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0answers
19 views

How to maximise utility in multi-periode model using martingale method

I am reading chapter 2.2 in Pascucci & Runggaldier (2012), Financial Mathematics - Theory and Problems for Multi-period Models about how to maximise utility in multi-periode model using martingale ...
3
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0answers
95 views

Equivalent martingale measure in time changed Levy models

I am investigating time changed Levy models. As far as I have seen, these models are usually directly described under the risk neutral measure $\mathbb{Q}$. However, I'm interested in first modelling ...
2
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0answers
28 views

Utility Maximization on a finite Probability Space. Possible mistakes in a paper?

I am currently reading this paper on utility maximization in a financial market model. On page 5 the author starts with the case of a finite probability space and on page 19 he considers the ...
8
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3answers
403 views

Measure theory in quantitative finance

When I read up on stochastic modeling, the use of "measure" comes up a lot. So far I just read the word "measure" as "probabilities" or "distribution" and was able to get away with it when trying to ...
4
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0answers
43 views

Martingale property of inhomogenous poisson process

I have found this martingale property for an inhomogenous poisson process with intensity $\lambda(s)$ which I don't know how to prove. The text itself advises: "proceed using Monotone class theorem". ...
2
votes
1answer
141 views

Calculating the stochastic integral of $\exp(-rt)S_t$

I am currently reading lecture notes which aim to show that if $$ S_t = S_0 \exp (\mu t + \sigma W_t) $$ then, under the probability measure $\tilde{\mathbb{P}}$ with density $$ \gamma_T = \exp (c W_T ...
2
votes
1answer
77 views

Changing to martingale probability world

This question is really getting me annoyed and I'm struggling to do the final proof, I have no problem obtaining the adjustment to the drift rate necessary to collapse the drift term to make it a ...
0
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0answers
46 views

Pricing kernel dynamics in a JDSV model

I have the following model \begin{align} d M_t & = r M_t dt \\ d S_t & = S_t [\alpha dt + \sqrt{V_t} d B_t + J d N_t] \\ d V_t & = k(\theta - V_t) dt + \eta\sqrt{V_t} \left(\rho d B_t +...
1
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0answers
85 views

Martingale approach - Option pricing with Radom-Nikodym

I would like to get the price of an option which pays at time T the minimum between the logarithm of (S(1,T) / S(1,0)) and the logarithm of (S(2,T) / S(2,0), with the following processes: (The two ...
1
vote
0answers
69 views

Hull Martingales and measures problem 27.16 7e?

Here's a question from Hull's Options Futures and Other derivatives which I'd appreciate if someone helped me to clarify. The question is from the chapter "Martingales and Measures" Suppose that the ...
1
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0answers
60 views

Does pricing contingent claims under the EMM require us to define the distribution?

I am familiar with martingale pricing as primarily a notational abstraction which allows us to price contingent claims on $X_\tau$ by its conditional expectation. Usually, we interpret this to mean ...
0
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0answers
52 views

Martingale Measure in Fundamental Asset Prcing Formula

I want to know when we use FAPF to price the Value of an Asset according to the formula, $$V_{asset} = \mathbb{E}^{P} [\sum_{\tau=0}^T (PV[C_\tau])]$$, where: $P$ is some equivalent probability ...
0
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1answer
122 views

Equivalent Martingale Measure result Hull?

I've been reading Hull's chapter about Martingales and measures where he states that if you have the dynamics of two securities as follows: \begin{align} \frac{df}{f} = (r + \lambda \sigma_f) dt + \...
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0answers
41 views

Relationship between two Brownian motions generated by equivalent martingale measures

If $Q^1$ and $Q^2$ is equivalent martingale measures ($Q^1\sim Q^2$) and the following condition holds: $$\frac{dQ^2}{dQ^1}=(\frac{X_T}{X_0})^q$$ for some positive constant $q$ and the $Q^1$ dynamics ...
8
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2answers
1k views

Intuitive Explanation for Shannon's Demon?

I am reading Fortune's Formula by William Poundstone, and I am puzzled by a phenomenon called "Shannon's Demon", which Claude Shannon allegedly proposed in a series of lectures, and preserved only by ...
2
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0answers
113 views

Is the VIX a Martingale?

Say the S&P500 follows a Gaussian diffusion process, so that: $$ VIX^2_{T,t}=\frac{1}{T}\mathrm{E}_t^\mathbb{Q}\left[\int_t^{t+T}\sigma_s^2ds\right] $$ where $T$ is the tenor (assume fixed), $t$ ...
2
votes
1answer
169 views

Test if a process (with no drift) is a martingale

Consider the process $$Z(t)=\int_{0}^{t} \frac{u^a}{t^a}dW_u$$ for some real constant $a$ and $W_t$ is a wiener process. I want to check whether this process is a $F_t^W$-martingale. I noticed Lemma 4....
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0answers
89 views

Constant volatility and risk-free rate assumptions of Black Scholes

I'm studying the risk-neutral derivation of Black-Scholes formula and feel confused about the requirement for the volatility of the underlying asset and the risk-free rate to be constant. It seems ...
1
vote
2answers
100 views

The two fundamental theorems of Finance, as they relate to the martingale measure

I RECENTLY read this in an article by Battig and Jarrow, "the first fundamental theorem relates the notion of no arbitrage to the existence of an equivalent martingale measure, while the second ...
3
votes
0answers
48 views

Martingales with power-law tails and CLT

I'm writing a course paper on stable distributions and I couldn't find any source discussing limits of Martingales with power-law tails. Suppose we have a Martingale that produces IID observations at ...
3
votes
1answer
157 views

Equality under T-forward measure for convexity adjustment

I've been working with the convexity adjustment for interest rates that arises when changing from one measure $Q_{T_p}$ with a numéraire $N_p=P(t,T_p)$ to a measure $Q_{T_e}$ with a numéraire $N_e=P(t,...
6
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1answer
225 views

Martingale measure result application for interest rates under T-forward measure?

I've got a question about the way the equivalent martingale measure result is used for pricing derivatives. Hull states the result as the next equality: \begin{align*} f_o = g_0 E^{g}\big(\frac{f_T}{...
1
vote
1answer
381 views

Change of measure between T-forward and T*-forward contract?

I am trying to prove the need of a convexity adjustment to a forward rate by calculating the next expectation: \begin{align*} P(t_0, T_s)E^{T_s}\big(L(T_s, T_s, T_e) \mid \mathcal{F}_{t_0}\big). \end{...
1
vote
1answer
246 views

Write expectation of brownian motion conditional on filtration as an integral?

Let $W_t$ be a Brownian motion, so $W_t=z_t \sqrt{t}$ where $z_t \in N(0,1)$ and the pdf of $z$ is $f(z)=\frac{e^{-\frac{z^2}{2}}}{\sqrt{2\pi}}$. So $$E(W_t)=\int_{-\infty}^{\infty} W_t f(z) dz =\...
0
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0answers
484 views

Proof that integral of Brownian motion wrt time is not a martingale

Let $X_t=\int_0^t W_s ds$ where $W_s$ is Brownian motion, so $E[W_s]=0$. Then $E[X_t]=\int_0^t E[W_s] ds=\int_0^t 0 ds=0$. So $E[X_t|{\cal F}_s]=0\neq X_s$, almost everywhere. So by previous ...
5
votes
1answer
160 views

Ito representation unique up to indistinguishability? Proof?

Given an Ito-process $X(t)$, $t\in[0,T]$ $$X(t)=X_{0}+\int_{0}^{t}F(s)ds + \int_{0}^{t}G(s)dW(s)$$ with $F\in \mathbb{L}^{1}(0,T)$ and $G\in\mathbb{L}^{2}(0,T)$. It is now often claimed that this ...
3
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0answers
33 views

Infinite Horizon Barrier Option Paradoxe [duplicate]

I've came across this question which is puzzling me. Imagine that interest rates are zero and that you observe a stock $S_t$ whose value today $S_0$ is equal to 1\$. We consider the derivative that ...
0
votes
1answer
94 views

Why calibration in $Q$ against option prices without showing that $Q$ is equivalent to $P$?

In practice, I have seen articles and financial textbooks on calibration of processes directly under the risk neutral world without showing that the measure is equivalent to a physical measure $P$. ...
3
votes
2answers
157 views

Pricing Equation for Best of Options

I am trying to derive a martingale pricing equation (closed form solution) for a best-of option. But I am getting stuck at a point. There are 2 stocks $U(t)$ and $V(t)$ they both follow GBM with a ...
2
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2answers
152 views

Calculate $E^{\mathbb{Q}}\left[e^{-\int_{0}^{T_2}r_t\,dt} \frac{S\left(T_2\right)}{S\left(T_1\right)}\right]$

Let $S\left(t\right)$ be a tradable financial security that doesn't generate cash flow (eg no dividend). $S\left(t\right)$ follows an unknown stochastic process. We now have a financial derivative ...
0
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0answers
428 views

Changing the numeraire, equivalent martingale measures

Why do we have $\overline Y_t\cdot X_t^1$ instead of $\overline Y_t\cdot X_T^1$ in the middle equation below ? (The page is from the book ''Stochastic Finance'' by Hans Föllmer and Alexander ...
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0answers
61 views

Clarification on martingale process, explain wikipedia paragraph

What does the following paragraph from this wikipedia page on Martingales mean? To contrast, in a process that is not a martingale, it may still be the case that the expected value of the process ...
3
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2answers
177 views

Equivalent martingale measure price dynamics

Assume $S_0(t)=\exp(\int_0^t r(s) ds)$. Then $\mathbb{Q}\sim \mathbb P$ is a martingale measure $\iff$ every asset price process $S_i$ has price dynamics under $\mathbb Q$ of the form $dS_i(t)...
5
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2answers
2k views

Why discounted derivative price is a martingale?

Usually after showing that discounted stock price process is martingale under the risk-neutral measure, most authors say that this implies that the discounted derivative price process is a martingale ...
3
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0answers
69 views

An arbitrage strategy involving forward contracts to show that LIBOR rates are martingales

I note $L_{t}^{[T_s, T_e]}$ the forward rate at time $t$ for the period $[T_s, T_e]$. Recall it is the strike making equal to $0$ the value at time $t$ of a forward contract for the period $[T_s, T_e]$...
4
votes
1answer
811 views

Girsanov Theorem application to Geometric Brownian Motion

I recently read this from a book on mathematical finance The important example for finance the (unique) EMM for the geometric Brownian. Let $S_{t}$ be the price of an asset, $${{d{S_t}} \over {{...
4
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0answers
117 views

Martingale method for utility maximization - is the optimal strategy also a martingale?

The Martingale Method for utility maximization (seen in e.g. Björk's book) is based on separating the optimization problem $E^\mathbb{P}[U(X_T)]$ over a class of admissible strategies into the static ...
6
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1answer
2k views

Convexity Adjustment for Futures

Let $B_t$ be the cash account numeraire. The future and forward prices at time t are expressed as: $$ Fut = E_t^Q\left[S_T\right],$$ $$ Fwd = \frac{E_t^Q[S_T/B_T]}{E_t^Q[1/B_T]}.$$ Where $$ \frac{...
3
votes
1answer
70 views

What is the martingale measure requirement when $\mu(t,S(t)) = \mu(t)$?

It is known that if the numeraire is the bank account, then the martingale measure is determined by the fact that every asset has $r$ as its local rate of return. However, the local rate of return is ...
1
vote
0answers
481 views

Forward price - T-forward martingale

I have a problem figuring out some of the calculations in the book: Fixed Income modelling In the chapter on forwards the author makes an argument that the forward is a martingale under the T-forward ...
3
votes
0answers
116 views

Expected value of a wiener process on an infinite time horizon with a barrier

Say I have a wiener process with $X(0) = X_0>0$ and the dynamics \begin{equation} dX(t) = \begin{cases} -\mu dt + \sigma X(t) dW(t)^{\mathbb{Q}} & \mathrm{for\ } X(t)>0\\ 0 & \mathrm{...
0
votes
1answer
528 views

Why is a martingale a risk-neutral measure

We have the risk-free valuation formula $$ \pi^X_i = B_T^{-1}B_iE_{P^*}[X|F_i]$$ Where $P^*$ is an equivalent martingale measure. Why is this martingale measure considered risk-neutral? All I know is ...