Foundations of Stochastic Processes – 046868

Final Exam: July, 2014

1. You may use class lecture notes, either hand written or the booklet by
Zakai, Shwartz and Zeitouni, plus additional handouts given during the
semester. No other external material is permitted.
2. This is a 24 hour, take home, exam. The solution has to be in my office,
or a high quality scan has to be sent by e-mail, within 24 hours of your
receiving the exam.
3. If you are working outside the Technion, and want to send me a poor
quality scan or smartphone picture of all pages to meet the deadline, then
this is also OK, but then I need the original within another 24 hours. This
can be left in my mailbox on the 8-th floor.
4. Good news – bad news.
Note that if you add up all the points per question, you will reach a total
of 128. This is not a mistake, but is a way to

(a) Acknowledge the fact that the exam is probably too long. (That’s the
bad news.)
(b) Allow you some choice in choosing what to answer. (That’s the good
news.)

Behatzlacha

1
Question 1: (32 points)
State which of the following statements is true and which is false. You get
1 point for each correct answer (-1 point for each wrong answer) plus 3 extra
points for the correct reasoning. You are allowed to cite results from the lecture
notes, derive your answer from a known result or provide a counter example.

For (i) and (ii) suppose that {Xn } and {Yn } are bounded martingales, with
respect to filtrations FnX and FnY .
Toss a coin, once only, independently of the martingales. If it comes up
heads (with probability p) choose the martingale {Xn } . Otherwise, choose
{Yn }. Call the new process, obtained this way, {Zn }.

(i) There exists a filtration with respect to which {Zn } is a martingale.

(ii) The limit limn→∞ Zn may fail to exist.

For (iii) and (iv) suppose that Z1 , Z2 , ... are independent random variables, such
that
an with probability 12 n−2






Zn = 0 with probability 1 − n−2



−an with probability 21 n−2



Pn−1
where a1 = 2 and an = 4 j=1 aj .

(iii) The limit limn→∞ Yn exists a.s.

(iv) The Yn have uniformly bounded expectations. That is, there exists an
M < ∞ such that E|Yn | ≤ M for all n.

(v) If {Xt : t ≥ 0} is a Gaussian process and s(t) : [0, ∞) → [0, ∞) is a

non-random function, then {Xs(t) : t ≥ 0} is also a Gaussian process.

(vi) The canonical filtration Gt of a stochastic process Xt is the same as the

canonical filtration Ht of the stochastic process Yt = eXt .

(vii) If τ = inf{n ≥ 0 : Sn = 10} for a symmetric simple random walk Sn on

the integers (that is, P{S1 = 1} = P{S1 = −1} = 1/2), then E{Sn ∧ τ } → 10 as
n → ∞.

(viii) With a positive probability there exist two random rational numbers 0 ≤
r(ω) < q(ω) ≤ 1 such that the sample path of the Brownian motion t → Wt (ω)
is monotone increasing in the open interval r < t < q.

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Question 2: (30 points, 6 per section)
Let (Wt )t>0 be a Brownian motion with the natural filtration (Ft )t>0 . Fix
RT
T > 0 and let f be a deterministic function with 0 f 2 (s)ds < ∞.
Rt
(i) For t > 0 find the distribution of 0
f (s) dWs .

(ii) By directly computing conditional expectation and using the result from
(i), prove that the process
Z t 1 t 2
Z 
Mt := exp f (s) dWs − f (s) ds , 06t6T
0 2 0

is a martingale with respect to (Ft ).

(iii) Now let us see what we can say about the process Mt in general case, when
the function f = f (s, ω) can be random. In order for the stochastic integral
in the definition of Mt to be well-defined we assume that f (t, ω) is adapted to
RT
the filtration (Ft ) and E 0 f 2 (s, ω)ds < ∞. Verify that for 0 6 t 6 T we have
Rt
Mt = 1 + 0 f (s, ω)Ms dWs a.s.

(iv) Introduce a stopping time τn := inf{t ∈ [0, T ] : |f (t)M (t)| > n} and put
τn = T if no such t exists. Check that for any fixed n > 0 the process
Z t
n
Mt := 1 + f (s, ω)Ms Ind(s 6 τn ) dWs , 0 6 t 6 T,
0

where Ind is an indicator function, is a martingale with respect to (Ft ).

(v) Using (iv), prove that the process (Mt ), 0 6 t 6 T is a supermartingale.

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Question 3: (30 points, 6 per section)
Let (Wt )t>0 be a Brownian motion with the natural filtration (Ft )t>0 . Let
f be a continuous bounded function whose first and second derivatives are also
continuous and bounded. Denote the density of a N (0, 1) random variable by
2
φ(x) := √12π e−x /2 .

(i) Let F (t, x) be a continuous function with continuous derivatives Fx0 , Fxx
00
,
0
Ft . Write a PDE for the function F and an additional condition that guarantee
that the process (F (t, Wt ))06t61 is a martingale.

(ii) Let Z ∞ √
U (t, x) = f (x + 1 − ty)φ(y) dy.
−∞

Using (i) and integration by parts, or otherwise, show that the process (U (t, Wt ))06t61
is a martingale with respect to (Ft ).

(iii) Apply Itô’s formula to prove that

Z ∞ Z 1
∂U
f (W1 ) := U (1, W1 ) = f (y)φ(y) dy + (t, Wt ) dWt .
−∞ 0 ∂x

(iv) Apply the formula for expected value of the square of stochastic integral
to verify the identity
Z ∞ Z ∞ 2
2
f (y)φ(y) dy = f (y)φ(y) dy
−∞ −∞
Z 1 Z ∞ Z ∞ √ √ 2
+ f 0 ( tx + 1 − ty)φ(y) dy φ(x) dxdt.
0 −∞ −∞

(v) Apply the Cauchy–Schwarz inequality to establish Poincaré’s inequality:

(Ef (X))2 6 Ef (X)2 6 (Ef (X))2 + Ef 0 (X)2 ,

where X is a standard Gaussian N (0, 1) random variable.

Hint.√If ξ and
√ η are independent N (0, 1) random variables, then the random
variable tξ + 1 − tη is also N (0, 1).

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Question 4: (36 points, 6 per section)
The Brownian sheet B is a process on the positive quadrant of the plane,
2 ∆
R+ = {t = (t1 , t2 ) : t1 ≥ 0, t2 ≥ 0}. It is defined by the fact that it is Gaussian,
with mean zero and covariance function

C(s, t) = E{B(s)B(t)} = (s1 ∧ t1 ) × (s2 ∧ t2 )

= (min(s1 , t1 )) × (min(s2 , t2 )).

(i) Show that the processes Ws : R+ → R defined by

Ws (t) = B(s, t) (1)

are, up to a scaling factor, regular Brownian motions.

Note: The meaning of (1) is that s is fixed, and t varies over R+ = [0, ∞).

(ii) Show that B is continuous but does not have (partial) derivatives.

(iii) If s, t ∈ R2+ , with sj ≤ tj , write [s, t] for the rectangle [s1 , t1 ] × [s2 , t2 ], and
define the “increment” of B over this rectangle as
∆
B([s, t]) = B(t1 , t2 ) − B(t1 , s2 ) − B(s1 , t2 ) + B(s1 , s2 ).

Find the distribution of B([s, t]) and show that if A1 and A2 are disjoint rect-
angles then B(A1 ) and B(A2 ) are independent.

For the remaining sections we now define integration on [0, 1]2 with respect to
B, but only for deterministic functions f : [0, 1]2 → R. Such an f is called r-
simple (rectangularly-simple) on [0, 1]2 if there exist disjoint rectangles Ai with
2
S
i Ai = [0, 1] and finite constants ai such that
X
f (t) = ai 1Ai (t).
i

Then we set Z
∆
X
I(f ) ≡ f (t) dB(t) = ai B(Ai ). (2)
[0,1]2 i

(iv) Find the mean, variance, and distribution of I(f ) for r-simple f .

(v) Find the covariance between I(f ) and I(g) for two r-simple functions f and
g.

(vi) Describe how one might extend (2) to a larger class of functions, so as to
obtain a more general integral. In particular, find a formula for the covariance
between I(f ) and I(g) in the more general case.
Note: Part (vi) is open-ended. You would have to spend days on this to do it
fully. Don’t! Just give some general pointers.