Questions tagged [stochastic-calculus]

A branch of mathematics that operates on stochastic processes.

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7
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2answers
298 views

Heston: Variance of Integrated Variance

Consider the standard Heston model\begin{align*} dX&=\left(r-\frac{1}{2}v\right)dt+\sqrt{v}dB,\\ dv&=\kappa(\theta-v)dt+\xi\sqrt{v}dW, \\ dBdW&=\rho dt. \end{align*} Computing $\mathbb{E}\...
2
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0answers
120 views

Derivation of Bergomi model

In Stochastic Volatility Modeling, L. Bergomi introduces in Chapter 7 the pricing equation (7.4) : $$ \frac{dP}{dt}+(r-q)S\frac{dP}{dS}+\frac{\xi^t}{2}S^2\frac{d^2P}{dS^2}+\frac{1}{2}\int_t^Tdu\int_t^...
0
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1answer
100 views

Question on Ito's lemma involving $\mathrm{d}W(t)$

I am new to Ito-calculus, so please forgive me if the question is stupid. Let $W(t)$ be a Brownian-Motion and $f(W(t))=W(t)^2$. If I want to calculate the differential $\mathrm{d}f(W(t))$, Ito's lemma ...
5
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0answers
69 views

Malliavin calculus on two different probability spaces

I'm studying Malliavin Calculus recently. I have two different text books, one is the lecture note written by Oksendal, and the other is a book (Introduction to Malliavin Calculus) by Nualart. In this ...
2
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1answer
60 views

Equivalent local martingale measure vs. equvalent martingale measure in a Brownian setup

Assume you have the standard financial market built up of a Brownian motion. I have seen some books say that an equivalent local martingale measure imples no arbitrage, and some say that an equivalent ...
2
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1answer
65 views

Finding Option Probability Density Using Local Volatility from Dupire Model

This question is different than pricing using dupire local volatility model and Is Dupire's local volatility model path independent to recover historical option price? I also asked this on Math ...
0
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1answer
52 views

In what cases characteristic function of (log-)price process is known?

Hey I know that we can use characteristic function of log-price process to price different options. But when we know the characteristic function? I know that we can take Levy processes and constant ...
0
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0answers
73 views

Quantitative interview questions - fixed income [duplicate]

I will pass a quant interview (fixed income). The interviewer said the questions do not have a right answer, they are not math exercises. He said the questions are like their job,the objective is to ...
2
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1answer
40 views

Showing that the shortfall-to-quantile ratio of a normal distribution goes to one

I dont get why $$\lim_{x \to \infty} \frac{\mu \{1 - \Phi(x)\} + \sigma \phi(x)}{(\mu + \sigma x) \{1 - \Phi(x)\} } = \lim_{x \to \infty} \frac{1}{1 - \sigma \frac{1 - \Phi(x)}{(\mu + \...
1
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0answers
39 views

Help in Bernoulli's differential equation

I want to solve the following Bernoulli differential equation: $$A'(t)=A^2(t)[-2\sigma +1]-2aA(t)$$ where $\sigma$ and $a$ are real numbers. Until now I have divided both sides of the equation with $A^...
2
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1answer
70 views

FX Asian Option Moment-matching in Harmonic case

I need to price a "foreign-paying" fixed-strike Asian (i.e., average) option. Thus, the payoff is: $$\left(\frac{A_T - K}{A_T}\right)^{+} = \left(1 - \frac{K}{A_T}\right)^{+} = K \left(\frac{...
2
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2answers
123 views

Sampling change in the driving brownian motion of a CIR process

I have volatility driven by a CIR process: $$\mathrm{d}v_t = \kappa (\bar{v}-v_t)\mathrm{d}t + \omega \sqrt{v_t}\mathrm{d}W_v\text{.}\tag{1}$$ I am working with several (complicated) approximations of ...
3
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1answer
159 views

Ito multiplication with jumps

Let $\{N_t|0<t\leqslant T \}$ and $\{M_t|0<t\leqslant T \}$ be two Poisson processes with intensities $\lambda_n, \lambda_m>0$, respectively. Based on the implicit results of Corollaries 1 ...
3
votes
1answer
138 views

Ito Lemma for Poisson Process

I'm new to stochastic calculus on jump processes and encountered a difficulty. I would appreciate some clarification from the community on the following question. Let $g_t$ be a $\mathcal{F_t}$-...
0
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0answers
58 views

How to Discretize this SDE found in finance? (cross-posted)

Continuous-Time In continuous-time form, the "Heston model" is written as $$ dS_t = \mu S_t dt + \sqrt{\nu_t} S_t dW_t^S \\ d\nu_t = \kappa (\theta - \nu_t) dt + \xi \sqrt{v_t} dW_t^{\nu} $$ ...
1
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0answers
83 views

Equivalence of Call Option on $S_T$ and Put Option on $\frac{1}{S_T}$ in FX Markets

Part 1: I am trying to price an option in the FX world. It naturally pays in the domestic currency, but in this case the payout currency must be the foreign currency. For example, consider the payoff: ...
1
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0answers
66 views

Price difference digital option : constant vol vs local vol

I got the following interview question: Consider a digital option, it will be priced by using two approaches: 1)constant volatility; 2)local volatility. At the strike, both volatilities are equal. (...
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0answers
116 views

Why were Laguerre polynomials a good choice of basis functions for American Monte Carlo?

I am implementing LSMC to price American options based on a custom model. I now need to make a choice of basis functions, so I am looking for the theoretical justification for using Laguerre ...
3
votes
1answer
149 views

Brownian Bridge general case

The SDE for the Brownian bridge is the following: $dY_t=\frac{b-Y(t)}{1-t}dt+dW(t)$ with solution: $Y(t)=Y(0)(1-t)+bt+(1-t)\int_0^t \dfrac{dW(s)}{1-s}$ Can someone help me on proving that $$\lim_{t\...
7
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0answers
200 views

On a time integral of Brownian motion up to the hitting time

Just come up with a 'simple' and interesting problem that I've been struggling to deal with for some time. Consider a filtered probability space $(\Omega, \mathcal{F}, \{\mathcal{F}_t\}_{t\in[0,T]},\...
3
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0answers
98 views

MGF of Generalised Itô Integral

The following derivation produces a moment closure problem - I would appreciate any insight. It may seem trivial at first glance, but the key aspect is the integrand dependence on $t$. Consider $W_t$ ...
5
votes
1answer
258 views

Is first order stochastic dominance conserved under change of measure?

As the title states, my question is whether first order stochastic dominance is conserved under change of measure, for instance from the $\mathbb{P}$ measure to $\mathbb{Q}$ measure and change of ...
3
votes
1answer
163 views

Bergomi Volatility Model

I was studying on the Bergomi volatility model(using forward variance represented as $\xi_{t}^{T}$).However I don't understand how the author passes from the sde to the first step by only integrating ...
1
vote
1answer
97 views

Deriving Law of Motion by Ito's Lemma

I've been trying to derive the law of motion for the stochastic process above using Ito's Lemma, given Geometric Brownian Motion with it's law of motion shown below: I've managed to take the partial ...
4
votes
1answer
92 views

Weak solution of a SDE

$\text { Consider the } \operatorname{SDE} d X_{t}=\operatorname{sign}\left(X_{t}\right) d t+d B_{t} \text { on } 0 \leq t \leq T, \text { where } \operatorname{sign}(x)=1\\ \text { for } x>0 \text ...
2
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0answers
76 views

Solving SDE Dubins-Schwarz Theorem

$\text{ Let } X_{t}=1+t+B_{t}, \text { and } T=\inf \left\{t: X_{t}=0\right\} . \text { Define } G(t)=\int_{0}^{t \wedge T} \frac{d s}{X_{s}}. $ $\text { Let }\ \tau_{t}=G^{-1}(t) \text { be the ...
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0answers
71 views

Changing order of integration on stochastic term in Vasicek [closed]

This question is in relation to the vasicek model, where i am trying to find the solution. I have this term: $-\int_{t}^{T} \sigma \int_{t}^{s} e^{-\kappa(s-u)} d W(u) d s$ I need to change the ...
4
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1answer
174 views

Conditional expectation of integral of brownian motion

I am trying to calculate $$\mathbb{E}\biggl[\biggl(\int_s^t W_u du\biggl)^2 \biggl|W_s=x, W_t=y\biggl] $$ where $W$ is a Standard Brownian Motion and $s\leq u \leq t$. Any help or tips would be ...
3
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0answers
60 views

Derivation of option pricing PIDE: Why does the drift need to be zero?

I started studying PIDE methods for option pricing and am struggling to understand or find the necessary theory that shows why the PIDE is obtained by the condition that the drift term has to be zero. ...
1
vote
1answer
154 views

How is the formula of Quadratic Variation of Brownian Motion derived? [closed]

This is a follow up on this question on quant SE: The question mentions for a Brownian motion : $X_t = X_0 + \int_0^t\mu ds + \int_0^t\sigma dW_t $ , the quadratic variation is calculated as $dX_t ...
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2answers
222 views

Is it a problem that there are so few stocks in the generalized Black Scholes market? [duplicate]

In the standard Black Scholes market there is only one stock. In the generealized market there can be a finite amount, but my impression is that there are few stocks in the market. The real world ...
2
votes
1answer
109 views

Calculating futures price

Consider a world as follows: $$\frac{dB}{B} = r_tdt$$ $$\frac{dS}{S} = r_tdt - 0.05dW_1 + 0.5dW_2$$ $$dr_t = 0.2 dW_1$$ where $r_0=0$. The Wiener processes $W_1$ and $W_2$ are independent. The price ...
2
votes
1answer
87 views

Integral of Brownian motion w.r.t. time and integral not starting at zero

I'm new to stochastic calculus and try to calculate (1) mean and (2) variance of $$\int_s^t W_u du$$ where $W_u$ is a Brownian motion. I already found this helpful answer, where it was shown that $\...
0
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0answers
42 views

Equivalence of two definitions of the stochastic integral

The Question I am reading Shreve's Stochastic Calculus for Finance, Volume II. On page 145, definition (4.4.20), he defines an integral with respect to an Itô process. Definition 4.4.5. Let $X(t) = X(...
3
votes
1answer
114 views

Justification for substituting “Itô differentials”

I'm reading Shreve's Stochastic Calculus for Finance, Volume II. In it, he uses the stochastic differential notation. For example, he may write $$\mathrm{d}X(t) = \sigma(t)\mathrm{d}W(t)+\alpha(t)\...
2
votes
1answer
89 views

Girsanov transform when drift coefficient is a function of the stock price

I'm working my way through an elementary stochastic calculus textbook. I'm having trouble with one of the questions: Bachelier type stock price dynamics. Let the SDE for stock price $S$ be given by $...
1
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1answer
96 views

Hermite polynomials as martingales [closed]

Let $\left\{W_{t}: t \geq 0\right\}$ be a standard B.M. on the filtered probability space $\left(\Omega, \mathcal{F},\left\{\mathcal{F}_{t}\right\}_{t \geq 0}, \mathbb{P}\right)$. Define the Hermite ...
4
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1answer
328 views

Ito calculus is Gaussian (using method of characteristic function)

Let $h$ be a deterministic function and define $X_{t}=\int_{0}^{t} h(s) d W_{s} .$ Show that $$\mathbb{E} \exp \left(i u X_{t}\right)=\exp \left(-\frac{u^{2}}{2} \int_{0}^{t} h^{2}(s) d s\right),$$ ...
0
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1answer
92 views

Mutual variation of Brownian motions

Let $\{W^1\}_{t\geq0}$ and $\{W^2\}_{t\geq0}$ be two Brownian motions with correlation coefficient $\rho \in [0, 1]$, i.e., $\mathbb{E}[(W^1(t)-W^1(s))(W^2(t)-W^2(s))]=\rho(t-s)$ for all $t,s \geq 0$. ...
0
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0answers
62 views

What is the difference between “stochastic” heat equation and just heat equation?

I am trying to understand the difference between the "stochastic" heat equation and the heat equation. Will i be wrong to say the stochastic heat equation is just the heat equationg with the ...
0
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1answer
108 views

Stochastic optimization and mean field games : textbooks

Which textbooks and online courses would you recommend to learn : stochastic optimization mean field games applied to quantitative finance. My goal would be to read research articles like the ones ...
0
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0answers
41 views

Fisher information of an Ornstein-Uhlenbeck process

I would like to compute the Fisher information of an Ornstein-Uhlenbeck process $X_t = Y_t - \beta Z_t$ where $Y_t$ and $Z_t$ are two time-series. My log-likelihood function in this case is: $$\...
3
votes
1answer
180 views

Help on solving a stochastic differential equation

I am trying to solve the following SDE $$dX(t)=rdt+aX(t)dW(t),\ t>0$$ $$X(0)=x$$ where W() is a Wiener process and r,a and x real numbers. I have proceeded by using the integrating factor $$F(t)=...
2
votes
2answers
210 views

Proving that a stochastic process is a martingale using Ito's Lemma

Assume a Wiener process W and a bounded F-adjusted stochastic process a. Show that the following process is a martingale on F $$X(t)=(\int_{0}^{t}a(s)dW(s))^{2}-\int_{0}^{t}a^{2}(s)ds,\ t\geq0$$ Can ...
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0answers
63 views

Query on Lebesgue Measure

I am reading Steven E. Shreve's book, titled "Stochastic Calculus for Finance II". I have a query w.r.t. an example given in the book which is as follows:-
5
votes
2answers
142 views

Expectation of integral where one of limits of integration is a random variable

Is it correct to write \begin{equation} E_t \int_0^{X_T} f(z) dz = \int_0^\infty \left(\int_0^x f(z) dz \right) p(x)dx \,\,? \end{equation} Here $X_T$ is a positive random variable with density $p(x)...
2
votes
1answer
60 views

Simplifying the expectation of the product of two stochastic integrals

Let $f(t, \omega), g(t, \omega)$ be functions that are independent of the increments of the Brownian motion $w(t, \omega)$ in the future. That is, $f(t, \omega), g(t, \omega)$ are independent of $w(t +...
3
votes
1answer
157 views

Derivative of Stochastic Integral

I am trying to take the derivative of the following stochastic integral, $$d\left(\int g(S_t) dS_t \right),$$ where $dS(t) = \sigma S(t) dW_t$ and $g(.)$ is some (smooth) deterministic function. My ...
2
votes
1answer
285 views

Reason for 0 in discounted stock price process

Let's assume $dD_t = rD_tdt$ ($D_t$ is Bond Price) and $dS_t = rS_tdt + σS_tdW_t$ The reference said $dD_tdS_t = 0$ But I don't understand the reason why it is zero. It said, the Bond Price is ...
1
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0answers
64 views

Replicating portfolio in the Heston model

Given the Heston model $$dS_t=\mu S_tdt+\sqrt{\nu_t}S_tdB_{1,t}\\ d\nu_t=k(\theta-\nu_t)dt+\eta\sqrt\nu_tB_{2,t}$$ how should the replicating portfolio $V_t$ for the derivative $F_t$ be composed? I ...

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