Questions tagged [stochastic-calculus]

A branch of mathematics that operates on stochastic processes.

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77 views

Valuation of Callable Bonds

Is there any way to price American Callable Bonds (those which can be called on any date before expiration) other than basic CRR interest rate trees, since they won't be accurate enough to give ...
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32 views

Stochastic process with determinstic frequency of regime changes

Suppose that I have an OU process. For instance, assume that I want to model the interest rates. Suppose that regime change is known ex ante, and is deterministic in terms of frequency (For instance, ...
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92 views

Log Contract payoff function

I can’t get where Dr. Rouah gets payoff function of log contract. Could you please take a look at that? https://frouah.com/finance%20notes/Variance%20Swap.pdf It’s on page 2, section 3. I couldn’t ...
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78 views

Unconditional Expectation vs. Conditional Expectation at time $0$

In most mathematical finance books I have read (all of them actually), the expectation, with respect to the sigma algebra at time $0$, $\mathcal F_0$, is considered the same as the unconditional ...
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88 views

The conditional expectation of a geometric brownian motion

In this question it states that $$\mathbb{E}[e^{\sigma(W_t-W_s)}|\mathcal{F}_s] = \mathbb{E}[e^{\sigma(W_t-W_s)}],$$ and I assume that $0 \leq s \leq t$. The accepted answer states that this step is ...
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54 views

Self financing strategy and repo rate

I was wondering how to adjust the self financing condition when cash borrowing cas be secured by the stock. Suppose the risk-free money account is $B_t$ and there is a risky asset $S_t$. One have ...
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54 views

Milstein discretization of the CIR process

Given the CIR process $\ dX_t = (a − bX_t ) dt + \sigma \sqrt{X_t}dW_t$ - I want to show that its Milstein scheme is $\ X_{i+1} - X_i = ((a − bX_i) - 0.25\sigma^2)\Delta + \sigma\sqrt{X_i}\sqrt{\...
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74 views

Proving Flow Property of Stochastic Differential Equation

I am trying to show that $X_t^{s,x} = X_t^{r, X_r^{s,x}}$ for $0 \leq s \leq r \leq t$, $x \in \mathbb{R}^n$ is a given initial condition for time $s$, for some SDE: \begin{equation*} d X(u)=b(X(u))d ...
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108 views

On quadratic covariation

I ran through an equality in a paper I was reading but couldn't check if it is correct. Let $W^1_t$, $W^2_t$ and $W^3_t$ be three brownian motions, not necessarily independent, is it true that the ...
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107 views

Ultra Powerfull Vibrato Montecarlo for delta sensitivities of a not regular payoff

Ciao, I am working on a derivative with the following payoff at time $T$: $$ \sqrt{(S_T - K)^+} $$ where $S_T$ is the value of the stock at the expiring date. As usual we will assume $S_t$ to be a ...
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68 views

kolmogorov backward equation intuition

The kolmogorov backward equation equation states that the probability density of a random variable $x$ which follows $dx= \mu dt + \sigma dw$ is given by $-p_t = \mu p_x + 0.5\sigma^2 p_{xx} $ ...
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77 views

Question about Stochastic Calculus,(change of measure)?

Can any one give some hint for this question? Let $\{S_t\}_{t=0}^\infty$ be an asset price process defined on the probability space $(\Omega,\mathcal{F},\mathbb{P})$. Assume that the log-return of $...
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26 views

Variance of integrated dynamical system

Define time increment $\mu:=t_{k+1}-t_{k}$. Consider the signal $x(\mu)-\mathbb{E}[x(\mu)]$ defined as $x(\mu)-\mathbb{E}[x(\mu)]=\frac{1}{\mu}\int_{t_{k}}^{t_{k+1}}\int_{0}^{\tau}e^{A(\tau-\delta)}...
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48 views

Model of asset substitution/risk shifting in continuous time

Consider a firm with cash flows $X_t$, which under a risk-neutral probability measure, follows a geometric brownian motion: $$dX_t = X_t[(r-\beta)dt + \sigma dZ_t]$$ where $r>0$ is the risk-free ...
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21 views

From one period to multi period risk neutral pricing

For a one period economy, we have the price of an asset as: $ p_0 = E^Q [p_1 * \frac {B0}{B1}] $ where $B0 = e^{-r_0}$ = time 0 price of risk free bond maturing at time =1 and $r_0$ is known at t0. ...
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95 views

Correlated GBM and OU processes

I want to model two different stochastic processes, such that: $X_t , V_t$ are correlated with coefficient $\rho$. Where: $\frac{dX_t}{X_t}=\mu_1dt+\sigma_1 dW_{1,t}$ and $dV_t=\theta(\mu_2-V_t)dt+\...
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133 views

Compo Feature in Asian Option on Futures

I'm pricing an Asian option on futures using Turnbull–Wakeman (other suggestions welcome) where the average is defined as $A _ { t _ { 1 } , t _ { n } } ^ { A , f } = \frac { 1 } { n } \sum _ { i = 1 }...
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38 views

If you have normally distributed returns, shouldn't you have the same adjustment factor as lognormally distributed?

We know that when using lognormal returns, the number you need to plug in is not the apparent return, but $\mu-\sigma^2/2$ because what you really have is, in essence, (1) a deterministic growth of $\...
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58 views

Extension of HJM to multiple factors

The HJM model calibrates the entire forward curve using the existing yield curve data and this results in the following expression for its instantaneous forward rate- $$df(t,T)=\sigma(t,T)\int_0^T\...
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200 views

Pricing a structured note instrument

I am trying to work out the following fixed income problem, where I am asked to price a structured note in Excel, which seems to me to be a reverse collar. My purpose was replicating this structured ...
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99 views

Geometric Brownian Motion: Drawdown as a function of time

Suppose I have a strategy (model it as the usual geometric Brownian motion with a drift). Question is, how does max drawdown grow as a function of duration?
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48 views

Is the 'constant weight in the risky asset' portfolio-strategy self-financing?

My question concerns a topic in quantitative finance that I feel is often brushed under the table: is a given strategy self-financing. We have two assets, one risky and one riskless, defined by the ...
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140 views

Characteristic function of SDE with coefficients depending upon second coupled SDE

Say we have the following two SDEs driven by the same single Brownian: $$ dx_t = -0.5\sigma^2g(\psi)^2dt + \sigma g(\psi)dW_t \quad\quad d\psi_t = -(H\psi_t+0.5\sigma^2)dt + \sigma dW_t$$ where $...
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53 views

Flow Variable and Stock Variable

I am new to stochastic control and I need your help! Suppose that we are a trader and we are trading based two sources of signal. One comes from the stock's flow of dividends as well as another trader'...
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337 views

Different definitions of arbitrage

Consider the following setup: Let $S=\left(S_1,\ldots,S_n\right)$ be a $n$-dimensional price process and denote by $V$ its value process defined by $V_t=\phi_t\dot\ S_t$ for $t=0,\ldots,T$. In "...
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80 views

Transformation of coupled forward-backward stochastic differential equations in 3 dimensions with Ito formula

Maybe this is the right place for my question: I have a system of coupled FBSDEs in 3 dimensions as follows (in cartesian coordinates): $$ \mathrm{d}\vec{r}(t) = \vec{u}(\vec{r}(t))\mathrm{d}t + \...
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58 views

Using malliavin derivative to find the worst Delta-positive hedge?

Background: I've heard that Malliavin Calculus can be used to show the explicit form of a delta-neutral hedge (given an SDE driven market model). For example, here is a sketch here on page 21 on how ...
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496 views

SDE for a portfolio of two correlated assets $ Y_{t} = 2 S^{1}_{t} S^{2}_{t}$

I am analysing a problem where I have two correlated stocks described by Brownian motions $$ \frac{dS^{1}_{t}}{S^{1}_{t}}=\mu_{1} dt + \sigma_{1} dW^{1}_{t} \quad \quad (1)$$ $$ \frac{dS^{2}_{t}}{S^{...
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64 views

Is there anyone tried to use simultaneous stochastic differential equations?

I am looking for some examples or attempts of using simultaneous stochastic differential equations for financial analysis but there has been none so far. Is it just so nasty to apply such thing in ...
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228 views

stochastic calculus and multidimentional itos lemma

I am considering a number of assets (N) in a portfolio. each asset follows a geometric Brownian motion process therefore the stochastic differential equation is dS(i) = S(i)μdt + S(i)σdX(i). The ...
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107 views

Term Structure and short rates

If I have a term structure/yield curve given by: $$f(t, T) = f(0, T) + σ^2t(T − \frac{t}{2}) + σB_t $$ and want to find the short/spot rate $r_t$, is this simply: $$f(t,t) = f(0,t) + \sigma^2t(t-\...
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102 views

Intensity Function of Stochastic Processes

I'm fitting some financial data to a model based on a stochastic process and evaluating the fit of it by looking at the compensator. However, I cannot understand well what does it mean to take the ...
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25 views

Call Option on the Square of a Log-Normal: Process of Underlying under Stock Measure and Risk Neutral Measure

I'm working on some quant interview questions from the book called Quant Job Interview Questions And Answers (by Mark Joshi and other authors). Here are the questions from the bookd, and the answers ...
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1answer
48 views

Arithmetic Asian Option

Assume the risk-free bond Bt and the stock St follow the dynamics of the Black & Scholes model without dividends (with interest rate r, stock drift $μ$ and volatility $σ$). Let $A_T:=\frac{1}{T}...
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34 views

Change of numeraire/probability when asset pays dividends

So I was looking at Margrabe's formula for exchange call options in the book 'Mathematical Methods for Financial Markets' (Jeanblanc, Chesney, Yor), and I was having trouble justifying their change of ...
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33 views

Filtrations and the different “kinds” of pre-knowledge

I am searching for a reference I think I saw in a book by either Shreve or Oskendahl. I am struggling with a theoretical question. As I recall how it was posed, the idea of no prior information (or ...
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37 views

Variance Equations is missing definition

here: https://www.nrc.gov/docs/ML1208/ML12088A329.pdf Campbell, Lo, Mackinlay: The Econometrics of Financial Markets on page 159 i am looking at equation 4.4.9 in the last line, = $I\sigma_{\...
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85 views

Approximating an SDE for Volatility Estimation

Consider the SDE $$ dT(t) = ds(t) + a(s(t) - T(t))dt + \sigma dW(t) $$ where $s(t)$ is a deterministic function that turns out to be the long-term mean (this SDE is used to model daily temperature, so ...
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1answer
140 views

When $E[f(\alpha,X)] = f(\alpha, E[X])$

When $E[f(\alpha,X)] = f(\alpha,E[X])$, where $f$ is some convex function of the first and second variables, except when the first variable takes the value $\alpha$ in which case the equality holds, ...
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2answers
394 views

Close form solution for Geometric Brownian Motion

I have a very fundamental problem, please help me out. I am little confused with the derivation for the close form solution for the Geometric Brownian Motion, from the very fundamental stock model: $$\...