Steven R.

Dunbar
Department of Mathematics
203 Avery Hall
University of Nebraska-Lincoln
Lincoln, NE 68588-0130
http://www.math.unl.edu
Voice: 402-472-3731
Fax: 402-472-8466

Stochastic Processes and

Advanced Mathematical Finance

Stochastic Differential Equations and the

Euler-Maruyama Method

Rating
Mathematically Mature: may contain mathematics beyond calculus with
proofs.

1
Section Starter Question
Explain how to use a slope-field diagram to solve the ordinary differential
equation
dx
= x.
dt
How would you turn that process into an algorithm to numerically compute
an approximate solution without a diagram?

Key Concepts
1. We can numerically simulate the solution to stochastic differential equa-
tions with an analog to Euler’s method, called the Euler-Maruyama
(EM) method.

Vocabulary
1. A stochastic differential equation is a mathematical equation relat-
ing a stochastic process to its local deterministic and random compo-
nents. The goal is to extend the relation to find the stochastic process.
Under mild conditions on the relationship, and with a specifying initial
condition, solutions of stochastic differential equations exist and are
unique.

2. The Euler-Maruyama (EM) method is a numerical method for

simulating the solutions of a stochastic differential equation based on

2
 the definition of the Itô stochastic integral: Given

dX(t) = G(X(t)) dt +H(X(t)) dW (t), X(t0 ) = X0 ,

and a step size dt, we approximate and simulate with

Xj = Xj−1 + G(Xj−1 ) dt +H(Xj−1 )(W (tj−1 + dt) − W (tj−1 ))

3. Extensions and variants of standard Brownian motion defined through

stochastic differential equations are Brownian motion with drift,
scaled Brownian motion, and geometric Brownian motion.

Mathematical Ideas
Stochastic Differential Equations: Symbolically
The straight line segment is the building block of differential calculus. The
basic idea behind differential calculus is that differentiable functions, no mat-
ter how difficult their global behavior, are locally approximated by straight
line segments. In particular, this is the idea behind Euler’s method for ap-
proximating differentiable functions defined by differential equations.
We know that rescaling (“zooming in” on) Brownian motion does not
produce a straight line, it produces another image of Brownian motion. This
self-similarity is ideal for an infinitesimal building block, for instance, we
could build global Brownian motion out of lots of local “chunks” of Brow-
nian motion. This suggests we could build other stochastic processes out
of suitably scaled Brownian motion. In addition, if we include straight line
segments we can overlay the behavior of differentiable functions onto the
stochastic processes as well. Thus, straight line segments and “chunks” of
Brownian motion are the building blocks of stochastic calculus.
With stochastic differential calculus, we can build new stochastic pro-
cesses. We do this by specifying how to build the new stochastic processes

3
locally from our base deterministic function, the straight line and our base
stochastic process, standard Brownian motion. We write the local change in
value of the stochastic process over a time interval of (infinitesimal) length
dt as
dX = G(X(t)) dt +H(X(t)) dW (t), X(t0 ) = X0 . (1)
Note that we are not allowed to write
dX dW
= G(X(t)) + H(X(t)) , X(t0 ) = X0
dt dt
since standard Brownian motion is nowhere differentiable with probability 1.
Actually, the informal stochastic differential equation (1) is a compact way of
writing a rigorously defined, equivalent implicit Itô integral equation. Since
we do not have the required rigor, we will approach the stochastic differential
equation intuitively.
The stochastic differential equation says the initial point (t0 , X0 ) is spec-
ified, perhaps with X0 a random variable with a given distribution. A de-
terministic component at each point has a slope determined through G at
that point. In addition, some random perturbation affects the evolution of
the process. The random perturbation is normally distributed with mean 0.
The variance of the random perturbation is (H(X(t)))2 at (t, X(t)). This is
a simple expression of a Stochastic Differential Equation (SDE) which deter-
mines a stochastic process, just as an Ordinary Differential Equation (ODE)
determines a differentiable function. We extend the process with the incre-
mental change information and repeat. This is an expression in words of
the Euler-Maruyama method for numerically simulating the stochastic
differential expression.
Example. A very simple stochastic differential equation is

dX = r dt + dW , X(0) = b

with r a constant. Take a deterministic initial condition to be X(0) = b. The

new process is the stochastic extension of the differential equation expression
of a straight line. The new stochastic process X is drifting or trending at
constant rate r with a random variation due to Brownian motion perturba-
tions around that trend. We will later show explicitly that the solution of
this SDE is X(t) = b + rt + W (t) although it is seems intuitively clear that
this should be the process. We will call this Brownian motion with drift.

4
Example. Another very simple stochastic differential equation is
dX = σ dW , X(0) = b
This stochastic differential equation says that the process is evolving as a
multiple of standard Brownian motion. The solution may be easily guessed as
X(t) = σW (t) which has variance σ 2 t on increments of length t. Sometimes
the new process is called Brownian motion (in contrast to standard Brownian
motion which has variance t on increments of length t).
We combine the previous two examples to consider
dX = r dt +σ dW , X(0) = b
which has solution X(t) = b+rt+σW (t), a multiple of Brownian motion
with drift r started at b. Sometimes this extension of standard Brownian
motion is called Brownian motion. Some authors consider this process di-
rectly instead of the more special case we considered in the previous chapter.
Example. The next simplest and first non-trivial differential equation is
dX = X dW .
Here the differential equation says that process is evolving like Brownian
motion with a variance which is the square of the process value. When the
process is small, the variance is small, when the process is large, the variance
is large. Expressing the stochastic differential equation as dX /X = dW we
may say that the relative change acts like standard Brownian motion. The
resulting stochastic process is called geometric Brownian motion and it
will figure extensively later as a model of security prices.
Example. The next simplest differential equation is
dX = rX dt +σX dW , X(0) = b.
Here the stochastic differential equation says that the growth of the process
at a point is proportional to the process value, with a random perturbation
proportional to the process value. Again looking ahead, we could write the
differential equation as dX /X = r dt +σ dW and interpret it to say the
relative rate of increase is proportional to the time observed together with a
random perturbation like a Brownian increment corresponding to the length
of time. We will show later that the analytic expression for the stochastic
process defined by this SDE is b exp((r − 21 σ 2 )t + σW (t)).

5
Stochastic Differential Equations: Numerically
The sample path that the Euler-Maruyama method produces numerically is
the analog of using the Euler method.
The formula for the Euler-Maruyama (EM) method is based on the defi-
nition of the Itô stochastic integral:

Xj = Xj−1 + G(Xj−1 ) dt +H(Xj−1 )(W (tj−1 + dt) − W (tj−1 )),

tj = tj−1 + dt .

Note that the initial conditions X0 and t0 set the starting point.
In this text, we use coin-flipping sequences of an appropriate length
scaled to create an approximation to W (t) just as in the section Approx-
imation to Brownian Motion. The coin-flipping sequences emphasize the
discrete nature of the simulations with an easily constructed random pro-
cess. This is consistent with the approach of this text which always uses
coin-flipping sequences to create random processes. Note that since the in-
crements W (tj−1 + dt)−W (tj−1 ) are independent and identically distributed,
we will use independent coin-flip sequences to generate the approximation of
the increments. The EM method could use independent normal random
variates directly to obtain the increments W (tj−1 + dt) − W (tj−1 ). Using
independent normal random variates directly would be easier and more effi-
cient. The exercises modify the example scripts to use independent normal
random variates directly.
Then

dW = W (tj−1 + dt) − W (tj−1 ) = W ( dt)

Ŵ (N dt) √ Ŵ (N dt)
≈ ŴN ( dt) = √ = dt √ .
N N dt
The first equality above is the definition of an increment, the second equal-
ity means the random variables W (tj−1 + dt) − W (tj−1 ) and W ( dt) have
the same distribution because of the definition of standard Brownian motion
which specifies that increments with equal length are normally distributed
with variance equal to the increment length. The approximate equality oc-
curs because of the approximation of Brownian motion by coin-flipping se-
quences. We generate the approximations using a random number generator,
but we could as well use actual coin-flipping. In Table 1 the generation of
the sequences is not recorded, only the summed and scaled (independently

6
 j tj Xj 2Xj dt dW Xj dW 2Xj dt + Xj +
Xj dW 2Xj dt +
Xj dW
0 0 1 0.2 0 0 0.2 1.2
1 0.1 1.2 0.24 0.2 0.24 0.48 1.68
2 0.2 1.68 0.34 -0.2 -0.34 0.0 1.68
3 0.3 1.68 0.34 0.4 0.67 1.01 2.69
4 0.4 2.69 0.54 -0.2 -0.54 0.0 2.69
5 0.5 2.69 0.54 0 0 0.54 3.23
6 0.6 3.23 0.65 0.4 1.29 1.94 5.16
7 0.7 5.16 1.03 0.4 2.06 3.1 8.26
8 0.8 8.26 1.65 0.4 3.3 4.95 13.21
9 0.9 13.21 2.64 0 0 2.64 15.85
10 1.0 15.85

Figure 1: Simulation with the Euler-Maruyama method of a process defined

by a stochastic differential equation.

sampled) outcomes.√ For convenience, take dt = 1/10, N = 100, so we need

Ŵ (100 · (1/10))/ 100 = T10 /10. Then to obtain the entries in the column
labeled dW in the table we flip a coin 10 times and record T10 /10. Take
r = 2, b = 1, and σ = 1, so we simulate the solution of

dX = 2X dt +X dW , X(0) = 1.

A computer program can produce such a table with the step size made much
smaller, presumably resulting in better approximation properties. In fact, it
is possible to consider kinds of convergence for the EM method comparable
to the Strong Law of Large Numbers and the Weak Law of Large Numbers.
See the Problems for examples.

Discussion
The numerical approximation procedure using coin-flipping makes it clear
that the Euler-Maruyama method generates a random process. The value of
the process depends on the time value and the coin-flip sequence. Each gen-
eration of an approximation will be different because the coin-flip sequence
is different. The Euler-Maruyama method generates a stochastic process

7
path approximation. To derive distributions and statistics about the process
requires generating multiple paths, see the Problems for examples.
This shows that stochastic differential equations provide a way to define
new stochastic processes. This is analogous to the notion that ordinary
differential equations define new functions to study and use. In fact, one
approach to developing calculus and the analysis of functions is to start
with differential equations, use the Euler method to define approximations of
solutions, and then to develop a theory to handle the passage to continuous
variables. This approach is especially useful for a mathematical modeling
viewpoint since the model often uses differential equations.
This text follows the approach of starting with stochastic differential
equations to describe a situation and numerically defining new stochastic pro-
cesses to model the situation. At certain points, we appeal to more rigorous
mathematical theory to justify the modeling and approximation. One impor-
tant justification asserts that if we write a stochastic differential equation,
then solutions exist and the stochastic differential equation always yields the
same process under equivalent conditions. The Existence-Uniqueness Theo-
rem shows that under reasonable modeling conditions stochastic differential
equations do indeed satisfy this requirement.

Theorem 1 (Existence-Uniqueness). For the stochastic differential equation

dX = G(t, X(t)) dt +H(t, X(t)) dW (t), X(t0 ) = X0

assume

1. Both G(t, x) and H(t, x) are continuous on (t, x) ∈ [t0 , T ] × R.

2. The coefficient functions G and H satisfy a Lipschitz condition:

|G(t, x) − G(t, y)| + |H(t, x) − H(t, y)| ≤ K|x − y|.

3. The coefficient functions G and H satisfy a growth condition in the

second variable

|G(t, x)|2 + |H(t, x)|2 ≤ K(1 + |x|2 )

for all t ∈ [t0 , T ] and x ∈ R.

8
Then the stochastic differential equation has a strong solution on [t0 , T ] that
is continuous with probability 1 and

sup E X 2 (t) < ∞

 
t∈[t0 ,T ]

and for each given Wiener process W (t), the corresponding strong solutions
are pathwise unique which means that if X and Y are two strong solutions,
then " #
P sup |X(t) − Y (t)| = 0 = 1.
t∈[t0 ,T ]

See [4] for a precise definition of “strong solution” but essentially it means
that for each given Wiener process W (t) we can generate a solution to the
SDE. Note that the coefficient functions here are two-variable functions
of both time t and location x, which is more general than the functions
considered in equation (1). The restrictions on the functions G(t, x) and
H(t, x), especially the continuity condition, can be considerably relaxed and
the theorem will still remain true.

Sources
This section is adapted from: “An Algorithmic Introduction to the Numerical
Simulation of Stochastic Differential Equations”, by Desmond J. Higham, in
SIAM Review, Vol. 43, No. 3, pp. 525-546, 2001 and Financial Calculus: An
introduction to derivative pricing by M. Baxter, and A. Rennie, Cambridge
University Press, 1996, pages 52-62. The Existence-Uniqueness Theorem is
adapted from An Introduction to Stochastic Processes with Applications to
Biology, by L. J. S. Allen, Pearson Prentice-Hall, 2003, pages 342-343 and
Numerical Solution of Stochastic Differential Equations, by Peter Kloeden
and Eckhard Platen, Springer Verlag, 1992, pages 127-131.

9
Algorithms, Scripts, Simulations
Algorithm
The scripts apply the EM method to simulate the solution of

dX = rX dt +σX dW , X(0) = b.

The parameters N for the number of steps in the EM method, T for the
ending time, and stochastic differential equation parameters r and s are set.
Find the time step and initialize the arrays holding the time steps and the
solution simulation.
Using M = 30N create a piecewise linear function ŴM (t) using the ap-
proximation scripts in Approximation to Brownian Motion. The parameter
30 is chosen according to the rule of thumb in the DeMoivre-Laplace Central
Limit Theorem, Central Limit Theorem. Then each time increment will have
30 coin flips, sufficient according to the rule of thumb to guarantee a scaled
sum which is appropriately normally distributed.
Then loop over the number of steps using the EM algorithm

Xj = Xj−1 + G(Xj−1 ) dt +H(Xj−1 )(W (tj−1 + dt) − W (tj−1 ))

and plot the resulting simulation.

Scripts
Geogebra GeoGebra
R R script for stochasticsdes.R
1 r <- -1 # growth / decay
rate
2 sigma <- 0.5 # relative
standard deviation
3 b <- 3 # initial
condition
4
5 M <- 100 # number of steps
for EM method to take
6 T <- 1 # maximum time
7 h <- T / M # time step
8 t <- seq ( length = M +1 , from =0 , by = h ) # t is the vector
[0 1 h 2 h 3 h ... Nh ]

10
 9 X <- array (0 , c ( M +1) ) # place to store
locations
10
11 N <- 30 * ( M +1) # number of steps
for the Brownian Motion approx
12
13 p <- 0.5
14 S <- array (0 , c ( N +1) )
15 rw <- cumsum ( 2 * ( runif ( N ) <= p ) -1 )
16 S [2:( N +1) ] <- rw
17
18 WcaretN <- function ( z ) {
19 Delta <- T / N
20
21 # add 1 since arrays are 1 - based
22 prior = floor ( z / Delta ) + 1
23 subsequent = ceiling ( z / Delta ) + 1
24
25 retval <- sqrt ( Delta ) * ( S [ prior ] + (( z / Delta +1) -
prior ) * ( S [ subsequent ] - S [ prior ]) )
26 }
27
28 X [1] <- b
29 for ( i in 1: M ) {
30 X [ i +1] <- X [ i ]+ r * X [ i ] * h + sigma * X [ i ] * ( WcaretN ( t [ i ]+ h ) -
WcaretN ( t [ i ]) )
31 }
32
33 plot (t ,X , " l " , xlim = c (0 , T ) , ylim = c ( X [1] - exp ( abs ( r ) * T +1) ,
X [1]+ exp ( abs ( r ) * T +1) ) )
34 title ( main = paste ( " r = " , r , " sigma = " , sigma , " steps = " ,
M))
35

Octave Octave script for stochasticdes.m

1 r = -1; # growth / decay rate
2 sigma = 0.5; # \ sigma
3 b = 3; # initial value
4

5 M =100; # number of steps for EM method to take

6 global T =1; # maximum time
7 h=T/M; # time step
8 t =(0: h : T ) ; # t is the vector [0 1 h 2 h 3 h ... Nh ]

11
 9 X = zeros ( size ( t ) ) ; # prepare place to store locations
10
11 global N = 30*( M +1) ; # number of steps for the
Brownian
12 # Motion approximation
13 global S ;
14 p = 1/2;
15 S = zeros ( N +1 , 1) ;
16 S (2: N +1) = cumsum ( 2 * ( rand (N ,1) <= p ) - 1) ;
17
18 function retval = WcaretN ( z )
19 global N ;
20 global T ;
21 global S ;
22 Delta = T / N ;
23
24 # add 1 since arrays are 1 - based
25 prior = floor ( z / Delta ) + 1;
26 subsequent = ceil ( z / Delta ) + 1;
27
28 retval = sqrt ( Delta ) *( S ( prior ) + (( z / Delta +1) - prior )
.*( S ( subsequent ) -S ( prior ) ) ) ;
29
30 endfunction
31

32 X (1) = b ; # initial height at t = 0

33 for i =1: M # start taking steps
34 X ( i +1) = X ( i ) + r * X ( i ) * h + sigma * X ( i ) *( WcaretN ( t ( i ) + h ) -
WcaretN ( t ( i ) ) ) ;
35 end ;
36

37 plot (t , X ) # plot more permanently

38 axis ([0 T X (1) - exp ( abs ( r ) * T +1) X (1) + exp ( abs ( r ) * T +1) ]) ;
# set axis limits
39 grid on ;
40 title ([ " r = " , num2str ( r ) , " , sigma = " , num2str ( sigma ) ,
" , steps = " , num2str ( M ) ] ) ;
41

Perl Perl PDL script for stochasticdes.pl

1 # #!/ usr / bin / pdl
2 use PDL :: NiceSlice ;
3

12
 4 $r = -1; # growth / decay rate
5 $sigma = 0.5; # standard deviation
6 $b = 3; # initial value
7
8 $M = 100; # number of steps for EM method to take
9 $T = 1; # maximum time
10 $h = $T / $M ; # time step
11 $t = zeros ( $M + 1 ) -> xlinvals ( 0 , $T ) ; # vector of [0 ,
1h , 2h , 3 h ... Mh ]
12 $X = zeros ( $M + 1 ) ;
13
14 $N = 30*( $M +1) ; # number of steps for the Brownian
Motion
15
16 $p = 0.5;
17 $S = zeros ( $N + 1 ) ; # the random walk
18 $S ( 1 : $N ) .= cumusumover ( 2 * ( random ( $N ) <= $p ) -
1 );
19

20 # function WcaretN interpolating random walk

21 sub WcaretN {
22 my $x = shift @_ ;
23 $Delta = $T / $N ;
24
25 $prior = floor ( $x / $Delta ) ;
26 $subsequent = ceil ( $x / $Delta ) ;
27
28 $retval =
29 sqrt ( $Delta )
30 * ( $S ( $prior )
31 + ( ( $x / $Delta ) - $prior )
32 * ( $S ( $subsequent ) - $S ( $prior ) ) ) ;
33 }
34
35 $X (0) .= $b ; # initial value at t = 0
36 for ( $i =0; $i <= $M -1; $i ++) { # start taking
steps
37 $X ( $i +1) .= $X ( $i ) + $r * $X ( $i ) * $h + $sigma * $X ( $i ) *( WcaretN
( $t ( $i ) + $h ) - WcaretN ( $t ( $i ) ) ) ;
38 }
39
40 # file output to use with external plotting programming
41 # such as gnuplot , R , octave , etc .
42 # Start gnuplot , then from gnuplot prompt
43 # plot " stochasticdes . dat " with lines

13
 44

45 open ( F , " > stochasticdes . dat " ) || die " cannot write : $ !
";
46 foreach $j ( 0 .. $M ) {
47 print F $t - > range ( [ $j ] ) , " " , $X - > range ( [ $j ] ) , " \
n";
48 }
49 close ( F ) ;
50

SciPy Scientific Python script for stochasticdes.py

1 import scipy
2
3 r = -1. # growth / decay rate
4 sigma = 0.5 # standard deviation
5 b = 3. # initial value
6

7 M =
100 # number of steps for EM method to take
8 T =
1. # maximum time , note type real
9 h =
T/M # time step
10 t =
scipy . linspace (0 ,T , M +1) # vector of [0 , 1h , 2h , 3 h ...
Nh ]
11 X = scipy . zeros ( M + 1 )
12
13 N = 30*( M +1) # number of steps for the Brownian Motion
14
15 # the random walk
16 p = 0.5
17 S = scipy . zeros ( N +1)
18 S [1: N +1] = scipy . cumsum ( 2*( scipy . random . random ( N ) <= p
) - 1 )
19
20 def WcaretN ( x ) :
21 Delta = T / N # T real coerces Delta
real
22 prior = scipy . floor ( x / Delta ) . astype ( int )
23 subsequent = scipy . ceil ( x / Delta ) . astype ( int )
24 return scipy . sqrt ( Delta ) *( S [ prior ] + ( x / Delta - prior
) *( S [ subsequent ] - S [ prior ]) )
25
26 X [0] = b # iniital value at t = 0
27 for i in range (0 , M ) :

14
 28 X [ i +1] = X [ i ]+ r * X [ i ]* h + sigma * X [ i ]*( WcaretN ( t [ i ]+ h ) -
WcaretN ( t [ i ]) )
29
30 # optional file output to use with external plotting
programming
31 # such as gnuplot , R , octave , etc .
32 # Start gnuplot , then from gnuplot prompt
33 # plot " stochasticdes . dat " with lines
34 f = open ( ’ stochasticdes . dat ’ , ’w ’)
35 for j in range (0 , M +1) :
36 f . write ( str ( t [ j ]) + ’ ’+ str ( X [ j ]) + ’\ n ’) ;
37
38 f . close ()

Problems to Work for Understanding

1. Graph an approximation of a multiple of Brownian motion with drift
with parameters b = 2, r = 1/2 and σ = 2 on the interval [0, 5] in two
ways.
(a) Flip a coin 25 times, recording whether it comes up Heads or Tails
each time, Scoring Yi = +1 for each Heads and Yi = −1 Pnfor each
flip, also keep track of the accumulated sum Tn = i=1 Ti for
i = 1 . . . 25.√Using N = 5 compute the rescaled approximation
Ŵ5 (t) = (1/ 5)T5t at the values t = 0, 1/5, 2/5, 3/5, . . . 24/5, 5 on
[0, 5]. Finally compute and graph the value of X(t) = b + rt +
σ Ŵ5 (t).
(b) Using the same values of Ŵ5 (t) as approximations for W (dt) com-
pute the values of the solution of the stochastic differential equa-
tion dX = r dt +σ dW , X(0) = b on the interval [0, 5].
2. Repeat the previous problem with parameters b = 2, r = −1/2 and
σ = 2.

15
3. Repeat the previous problem with parameters b = 2, r = 1/2 and
σ = −2.
4. Modify the scripts to use normally distributed random deivates and
then simulate the solution of the stochastic differential equation
dX(t) = X(t) dt +2X(t) dX
on the interval [0, 1] with initial condition X(0) = 1 and step size
∆t = 1/10.
5. Modify the scripts to use normally distributed random deviates and
then simulate the solution of the stochastic differential equation
dX(t) = tX(t) dt +2X(t) dX
on the interval [0, 1] with initial condition X(0) = 1 and step size
∆t = 1/10. Note the difference with the previous problem, now the
multiplier of the dt term is a function of time.
6. Modify the scripts to use general functions G(X) and H(x) and then
apply it to the SDE for the
(a) Ornstein-Uhlenbeck process:
dX = θ(µ − X(t)) dt +σ dW (t), X(t0 ) = X0 .

(b) Cox-Ingersoll-Ross process:

p
dX = θ(µ − X(t)) dt +σ (X(t)) dW (t), X(t0 ) = X0 .

(c) the modified Cox-Ingersoll-Ross process:

p
dX = −θX(t) dt +θ (X(t)) dW (t), X(t0 ) = X0 .

7. Write a program with parameters r, σ, b, T and N (so dt = T /N )

that computes and graphs the approximation of the solution of the
stochastic differential equation
dX(t) = rX(t) dt +σX(t) dX
with X(0) = b on the interval [0, T ]. Apply the program to the stochas-
tic differential equation with r = 2, σ = 1, b = 1, and N = 26 , 27 , 28 on
the interval [0, 1].

16
 8. Generalize the program from the previous problem to include a param-
eter M for the number of sample paths computed. Then using this
program on the interval [0, 1] with M = 1000, and N = 28 compute
1 2
E [|Xn − X(1)|], where X(1) = ber− 2 σ +σŴ28 (1) .

9. Using the program from the previous problem with M = 1000 and N =
1 2
25 , 26 , 27 , 28 , 29 compute E [|XN − X(1)|], where X(1) = ber− 2 σ +σŴ29 (1) .
Then for the 5 values of N , make a log-log plot of E [|XN − X(1)|] on
the vertical axis against ∆t = 1/N on the horizontal axis. Using the
slope of the resulting best-fit line experimentally determine the order
of convergence γ so that

E [|XN − X(1)|] ≤ C(∆t)γ .

Reading Suggestion:
References
[1] Linda J. S. Allen. An Introduction to Stochastic Processes with Applica-
tions to biology. Pearson Prentice-Hall, 2003.

[2] M. Baxter and A. Rennie. Financial Calculus: An introduction to deriva-

tive pricing. Cambridge University Press, 1996. HG 6024 A2W554.

[3] Desmond J. Higham. An algorithmic introduction to numerical simula-

tion of stochastic differential equations. SIAM Review, 43(3):525–546,
2001.

[4] P. Kloeden and E. Platen. Numerical Solution of Stochastic Differential

Equations, volume 23 of Stochastic Modelling and Applied Probability.
Springer, 1992.

17
Outside Readings and Links:
1. Matlab program files for Stochastic Differential Equations offers a num-
ber of MATLAB routines for stochastic differential equations.

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that the links are active at all times. Use the links here with the same caution as
you would all information on the Internet. This website reflects the thoughts, in-
terests and opinions of its author. They do not explicitly represent official positions
or policies of my employer.
Information on this website is subject to change without notice.
Steve Dunbar’s Home Page, http://www.math.unl.edu/~sdunbar1
Email to Steve Dunbar, sdunbar1 at unl dot edu
Last modified: Processed from LATEX source on August 2, 2016

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