Fourier Analysis

Introduction
Fourier analysis: The process of decomposing a function into simpler pieces
Fourier synthesis: The operation of rebuilding the function from the pieces
In mathematics, the term Fourier analysis often refers to the study of both
operations
The transform is often given a more specific name depending on the domain
and other properties of the function being transformed.
The original concept of Fourier analysis has been extended over time to apply
to more and more abstract and general situations, and the general field is
often known as Harmonic Analysis
Variants of Fourier Analysis
Fourier Series: Used for one period of periodic
functions

Fourier Transform: Used for Continuous Time
Functions, may or may not be periodic

Discrete Time Fourier Transform (DTFT)

Discrete Fourier Transform (DFT)
Fourier Series
Complicated periodic (repeating) functions are taken and written as a sum of
simple waves

These waves are represented as Sine and Cosine functions to reflect their periodic
nature, amplitude and characteristic features

These trigonometric representations are further broken down into complex
exponentials using

Eulers Formula:


This representation reflects the wave information on the unit circle reflecting its
periodic nature
e
iq
= cosq + j sinq
Illustration of Fourier Series / Transform
Red is the complex signal
Blue waveforms are the constituting parts of the complex signal
Final graph shows the sine and cosine representations being shown in the complex
exponentials
Amplitude (magnitude) of the waves is preserved
The spacing reflects the frequency distribution of the constituent waves
Please play video.
Fourier Transformation
The Fourier Transform is one of the variants of Fourier analysis.

The Fourier Transform is mathematical transformation used to transform signals
between time (or spatial) domain and frequency domain.

The signal doesnt need to be periodic like Fourier Series

The Transform is applied on the entire signal, hence the limits used extend to infinity

When considering periodic functions over time the Fourier Transform may be
simplified to obtain a discrete set of complex amplitudes which represents the
frequency spectrum of the original time domain signal.
Mathematical Background
Fourier Transform:
S( f ) = F(s(t)) = s(t)e
i 2 ft
dt

Inverse Fourier Transform:

s(t) = F
1
(S( f )) = S( f )e
j 2 ft
df

S(f) = Function / Signal in the frequency domain

F() = Fourier Transform function
s(t) = Function / Signal in time domain
e
-i.2pi.f.t
= Breaking down into complex exponential components

Inverse Function
Frequency domain function
Applications of Fourier Transform
Due to all the properties of the Fourier Transform and the operations that can be
carried out on functions in the alternate domain it is widely used in Physics, Number
Theory, Differential Equations, Acoustics, Probability Theory, Statistics, Option Pricing ,
Numerical Analysis, etc.

The transforms may me used to apply certain frequency based filters.
Some of the properties responsible for this are:

Linearity: h(x) = a . f(x) + b . g(x), then

Translation if then

Scaling

They can be used to represent differential equations as constant coefficients

Used to turn convolution operations to multiplication
Applications
Fourier analysis can isolate individual components of a compound waveform,
concentrating them for easier detection and processing.

Many Signal processing techniques consist of Fourier-transforming a signal,
manipulating the Fourier-transformed data in a simple way, and reversing the
transformation.

Eg. Passive sonar used to classify targets based on machinery noise.

Applications of Fourier Transform
In Business
Binomial Options Pricing: Introduction
The binomial pricing model traces the evolution of an option's key underlying
variables in discrete-time. This is done by means of a binomial lattice (tree), for a
number of time steps between the valuation (when purchasing the option of buying a
stock at the strike price) and expiration dates (the date when the option to buy at
strike price expires). Each node in the lattice represents a possible price of the
underlying at a given point in time.
Fourier Transform in Options Pricing
According to the BOPM at maturity of the option it can have many different values and
to compute the option price the Binomial Options Pricing Model applied to a circle.
Conventional Approach
a is the vector containing all the possible values the option can have at maturity
b is the vector containing the conditional one period risk neutral probabilities
padded with 0s to be of the same length as a.
To compute option price at t=2, the following formula is applied:
This approach is said to be 3 times faster to process than the conventional approach
and when dealing with large quantities of data
This value can be calculated by the application of the Fourier Transform which converts
the convolution to a multiplication operator and thus saves computing time.
N = number of periods to maturity
C
0
= Risk Neutral / no arbitrage price of the option at time = 0
The End

Thank You