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Stochastic Integration
Introduction
In this chapter we will study two type of integrals:
for a t b
Stochastic Integration.nb
Denotation:
J H f L = J H f L HwL := f Hs, wL s
b
for a t b
for a t b
In this and the next section there are 3 other conditions in addition to f HSP
Hc1L
Hc2L
Hc3L
f Ht2 L - f Ht1 L2RV = E f Ht2 L - f Ht1 L2 k2 t2 - t1 for any t1 , t2 e @a, bD for a positive constant k2
f is nonanticipating on @a, bD
k2 Hb - aL + f HaLRV
The third conditions means that f Ht, wL doesn't depend on time t ' for t ' > t.
Example:
Hence,
t+b
M
2
is anticipating for a t b.
for
t+b
2
t+b
2
t' b
Definition: Let fm Ht, wL =i=0 fiHmL HwL Ii HtL be an element of SSP. Then
m-1
m-1
where a = t0 t1 ... tm = b and maxi ti+1 - ti 0 as m , fiHmL HwL = f Hti , wL and let Ii HtL =
for i = 0, ..., m - 1
Notice: J H fm L HRV
proof!
1 for ti t ti+1
0 otherwise
Stochastic Integration.nb
Notice: 8J H fm L<
Cauchy sequence in HRV .
m=1
proof!
Thus, 8J H fm L<
m=1 converges in HRV as m . This limit is defined to be J H f L.
Definition: f HSP and a sequence 8 fm <
m=1 SSP such that f - fm SP 0 as m , then
J H f L = f HsL s :=limm
b
m-1
a f HsL s = limm i=0 f Hti L Dt
b
where Dt =
b-a
, ti
m
Notice: f - fm 2SP 0 as m .
proof!
Now consider integrals of the form
for a t b
= a + i Dt
Stochastic Integration.nb
for a t b
for a t b
Like the prewious section f HSP and satisfis the three conditions.
Definition: For nonanticipating fm SSP where fm Ht, wL =i=0 fiHmL HwL Ii HtL and fiHmL HRV for each i and m, then
m-1
m-1
1 for ti t ti+1
0 otherwise
for i = 0, ..., m - 1
Notice: IH fm L HRV .
proof!
Notice: 8IH fm L<
m=1 is a Cauchy sequence in HRV.
proof!
HmL
= b where tiHmL = i Dt + a for i = 0, 1, ..., m and Dt =
Define a family of partitions of @a, bD by a = t0HmL t1HmL ... tm
Let
m-1
HmL
1 for tiHmL t ti+1
0 otherwise
Notice: f - fm 2SP 0 as m .
*proof!
Definition: (Ito stochastic integral)
Let f HSP satisfy conditions Hc1L - Hc3L. Then,
IH f L = limm
HmL
fm HtL W HtL = limm i=0 f ItiHmL M IW Iti+1
M - W ItiHmL MM
m-1
where tiHmL = a + i
b-a
m
b-a
.
m
Stochastic Integration.nb
proof!
Definiton: (Ito stochastic integral)
Let f HSP satisfy conditions Hc1L - Hc3L. Then,
HmL
IH f L HtL = limm i=0 f ItiHmL M IW Iti+1
M - W ItiHmL MM
where tiHmL = a + i
m-1
t-a
m
J H f + gL = J H f L + J HgL
I H f + gL = I H f L + IHgL
J Hc f L = c J H f L
IHc f L = c IH f L
EHIH f LL = 0
E I H f L2 = a E f HtL2 t
b
proof!
Example: Let IH f L = t W HtL. Then,
1
EHIH f LL = 0 and E I H f L2 = t2 t =
1
3
Example: Let IH f L =
2
-W HtL
1
2
W HtL
t+Dt
This double integral can't be evaluated exactly so approximations must be used to estimated this integral.
`
I H1, 2L = m-1
i=0
ti
ti+1
ti
0
W1 HrL W2 HsL = i=0 HW1 Hti L - W1 Ht0 LL HW2 Hti+1 L - W2 Hti LL where
m-1
ti = t + i
Dt
,t
M M
= t + Dt
Stochastic Integration.nb
Stochastic Integralfunction
WHtL
1.0
0.5
0.2
0.4
0.6
0.8
1.0
-0.5
-1.0
-1.5
-2.0
t
WHsLs
0
0.4
0.2
0.2
0.4
0.6
0.8
1.0
-0.2
-0.4
-0.6
-0.8
-1.0
t
WHsLWHsL
0
1.5
1.0
0.5
0.2
-0.5
0.4
0.6
0.8
1.0
Stochastic Integration.nb
b-a
.
N
J H f L J N H f L := i=0 f Hti L Dt
N-1
Then
J H f L - J N H f L2RV
Hb-aL3 k2
,
2N
1
N
b-a
.
N
Then
IH f L - IN H f L2RV
Hb-aL3 k2
,
2N
1
N
Notice that in either approximation, J N H f L or IN H f L, the respective integral is estimated for only one sample path. To approximate expectations involving stochastic integrals, many sample paths are needed.
For example:
EHgHIH f LLL
1
M
t W HtL W HtL,
i
N
H jL
1
M
N-1 HNL
HNL
ti W H jL ItiHNL M IW H jL Iti+1
M - W H jL ItiHNL MMN
Mj=1 Ji=0
for i = 0, 1, ..., N
Stochastic Integration.nb
0.14071
0.10929
0.19151
0.05849
0.21906
0.03094
25
0.23508
0.01492
0.24209
0.00791
0.24486
0.00514
0.24821
0.00179
0.14149
0.10851
0.18790
0.06209
24
0.20798
0.04201
0.23636
0.01363
0.26143
0.01143
27
0.24132
0.00867
0.24669
0.00330
Let IH f L =
2
Exercise 3.4:
-W HtL
2
W HtL
E I H f L2 = ? (2 (-1))
3.69026
0.25369
23
3.56893
0.13236
24
3.49926
0.06269
3.44867
0.01210
26
3.44178
0.00521
27
3.43668
0.00011
3.44086
0.00429
Stochastic Integration.nb
2 -W HtL
2
0
W HtLF
-W HtL
2
W HtL
E I H f L2 = ? (2 (-1))
a@jD =
n1
i=1
Sn@@iDD
n
T@@i + 1DD
F
PrintB"E=", M1 = AbsBNB
1
m
F
E=3.33538
8337.055, Null<
Error
0.10118
Varriance
162.713
a@jDFFF, 81<F
j=1
10
Stochastic Integration.nb
k := 2
n := 200
m := 20 000
TimingBDoB
Clear@bD
ForBj = 1, j < m + 1, j ++,
T = Table@ 1 + 2 Random@IntegerD, 8s, 1, n<D;
j
k
b@jD =
n
n1
k
n
Sn@@iDD
i=1
F
PrintB"E=", M2 = AbsBNB
1
m
F
E=3.4289
8319.069, Null<
Error
0.00766223
Varriance
17.2767
b@jDFFF, 81<F
j=1
Stochastic Integration.nb
for a t b,
E f HtL2 2 k2 Hb - aL + 2 f HaL2RV
k2 Hb - aL + f HaLRV for a t b.
for any t @a, bD
for a t b.
An important result is Ito's formula which says that a smooth function, F Ht, X HtLL, of the stochastic process X HtL also
satisfies a stochastic differential.
Hc4L
Hc5L
For function G : @a, bD , there exists a nonnegative constant k3 such that for any
t1 , t2 @a, bD and any X HSP then
E G Ht2 , X Ht2 LL - G Ht1 , X Ht1 LL2 k3 It2 - t1 + E X Ht2 L - X Ht1 L2 M.
Let F be a function of t and x. Assume that F Ht, xL has the cintinuous derivates
FHt,xL FHt,xL 2 FHt,xL 2 FHt,xL 2 FHt,xL
, x , t2 , 2 x , t x
t
11
12
Stochastic Integration.nb
f HtL
FHt,xL
,
x
1
2
gHtL
2 FHt,xL
FHt,xL
, gHtL
x
x2
FHt,xL
FHt,xL
f Ht, xL =
+ f HtL
+
t
1
2
g2 HtL
2 FHt,xL
x2
and
FHt,xL
gHt, xL = gHtL
.
x
Example:
1
2
IW 2 HtL - W 2 H0LM - 2 .
t
Example: WHtL - 1 =
t1
0 2
Example: Let r HtL = EIWHtL M show that rHtL satisfies the initial value problem
rHtL = EIWHtL M = 2 .
t
where tiHmL = a + i
b-a
m
HmL
HmL
m-1 f Iti M+ f Iti+1 M
HmL
IW Iti+1
M - W ItiHmL MM
r HtL
t
1
2
Stochastic Integration.nb
In the summation,
HmL
f ItiHmL M+ f Iti+1
M
HmL
and IW Iti+1
M - W ItiHmL MM are not likely to be independent. Consequently, Ito and Stratonovich
IW 2 HtL - W 2 H0LM
1
2
It is useful to be aware that Ito and Stratonocich stochastic differential equations are closely related. In particular, if X HtL
satisfies the Stratonovich stochastic differential equation
X HtL = X H0L + f Hs, X HsLL s + gHs, X HsLL W HsL
t
1 gHs,X HsLL
2
x
Hence,
for i = 1, 2, ..., n
for i = 1, 2, ..., n
n .
Let FHt, XL be a smooth function of t and X. That is, F : @a, bD HSP
F
xi
1 2 F
2 xi x j
F
x1
f1 +
1 2 F
2 x21
2
2
Ig11
+ g12
MO t +
F
x1
g11 W1 +
F
x1
g12 W2
Example: Let X1 HtL = a W1 HtL + b W2 HtL with X1 H0L = 0 and a and b are nonzero constants. Let FHt, X1 L = X12 .
In this case:
13