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Ito Integral, Ito's Formula and SDEs
Ito Integral, Ito's Formula and SDEs
o integral, It
os formula and SDEs
2, if 0 t 1,
1. (a) Let X(t) = 3, if 1 < t 3,
5, if 3 < t 4.
or in oneR formula X(t) = 2I[0,1] (t) + 3I(1,3] (t) 5I(3,4] (t). Give the Ito
integral 04 X(t)dB(t) as a sum of random variables, give its distribution,
specify the mean and the variance.
Solution.
Z 4 Z 1 Z 3 Z 4
X(t)dB(t) = 2dB(t) + 3dB(t) + 5dB(t)
0 0 1 3
= 2(B(1) B(0)) + 3(B(3) B(1)) 5(B(4) B(3)).
2. Give the values of for which the stochastic integral 01 s dB(s) is defined.
R
In the case when the integral is defined, give its mean and variance.
Solution.
Stochastic integral 01 s dB(s) is defined if and only if 01 s2 ds < (see
R R
3. Using Itos formula, find the following stochastic differentials dXt and give
their integral representations.
(a) Xt = eBt
Solution.
Take f (x) = ex . Then f 0 (x) = f 00 (x) = ex . So we have
1
dXt = d(eBt ) = f 0 (Bt )dBt + f 00 (Bt )dt
2
1
= eBt dBt + eBt dt.
2
Integral representation:
Z t
Bt B0 1 Z t Bs
Bs
e = e + e dBs + e ds
0 2 0
Z t Z t
1
= 1+ eBs dBs + eBs ds.
0 2 0
(b) Xt = sin(Bt )
Solution.
Take f (x) = sin(x). Then f 0 (x) = cos(x) and f 00 (x) = sin(x). So we
have
1
dXt = d(sin(Bt )) = cos(Bt )dBt + ( sin(Bt ))dt
2
1
= cos(Bt )dBt sin(Bt )dt.
2
Integral representation:
Z t
1Z t
sin(Bt ) = sin(B0 ) + cos(Bs )dBs sin(Bs )ds
0 2 0
Z t
1Z t
= cos(Bs )dBs sin(Bs )ds.
0 2 0
(c) Xt = sin(Bt2 )
Solution.
Take f (x) = sin(x2 ). Then f 0 (x) = 2x cos(x2 ) and f 00 (x) = 2 cos(x2 )
4x2 sin(x2 ). So we have
1
d(sin(Bt2 )) = 2Bt cos(Bt2 )dBt + 2 cos(Bt2 ) 4Bt2 sin(Bt2 ) dt
2
= 2Bt cos(Bt )dBt + cos(Bt2 ) 2Bt2 sin(Bt2 ) dt.
2
Integral representation:
Z t Z t
sin(Bt2 ) = sin(B02 ) + 2Bs cos(Bs2 )dBs + cos(Bs2 ) 2Bs2 sin(Bs2 ) ds
0 0
Z t Z t
= 2 Bs cos(Bs2 )dBs + cos(Bs2 ) 2Bs2 sin(Bs2 ) ds.
0 0
(d) Xt = t + Bt2 .
Solution.
d(t + Bt2 ) = dt + d(Bt2 ). For d(Bt2 ), take f (x) = x2 . Then f 0 (x) = 2x and
f 00 (x) = 2. So we have
1
d(Bt2 ) = 2Bt dBt + (2)dt
2
= 2Bt dBt + dt.
Hence,
Integral representation:
Z t Z t
t+ Bt2 = 0+ B02 +2 Bs dBs + 2 ds
0 0
Z t
= 2 Bs dBs + 2t.
0
Rt
4. Show that 0 Bs dBs , 0 t T , is a martingale
Solution.
(a) From Question 3(d) (or Example on p.37) we have
Z t
1
Bs dBs = (Bt2 t).
0 2
Let Mt = 12 (Bt2 t). We check the integrability and the martingale property
of Mt . Integrability:
1
E|Mt | = E|Bt2 t|
2
1
(E|Bt2 | + t) by triangular inequality
2
1
= (t + t) = t < .
2
Martingale property: We first compute E (Bt2 |Bu , u s) for s < t,
E Bt2 |Bu , u s = E (Bs + (Bt Bs ))2 |Bu , u s
= E Bs2 + 2Bs (Bt Bs ) + (Bt Bs )2 |Bu , u s
= Bs2 + 2Bs E (Bt Bs |Bu , u s) + E (Bt Bs )2 |Bu , u s
= Bs2 + 2Bs E (Bt Bs ) + E (Bt Bs )2 by independence
= Bs2 + 2Bs (0) + (t s) as Bt Bs N (0, t s)
= Bs2 + t s.
Then, for s < t,
1 2
E (Mt |Mu , u s) = E (B t)|Bu , u s
2 t
1 2
= E Bt |Bu , u s t
2
1 2
= Bs + t s t
2
1 2
= Bs s = Ms
2
Rt
Thus, 0 Bs dBs = 12 (Bt2 t) is a martingale.
(b) Ito integral 0t Bs dBs , 0 t T is a martingale if
RT
E(Bs2 )ds < (see
R
0
Proposition at top of p. 38). Since we have
#T
s2 T2
Z T Z T "
E(Bs2 )ds = sds = = < ,
0 0 2 0
2
Rt
the Ito integral 0 Bs dBs is a martingale.
5. Show that eBt t/2 is a martingale by using Itos formula for the function ext/2
and properties of Itos integral.
Solution.
Let Xt = Bt and f (x, t) = ext/2 . We use Itos formula for f (Xt , t) (see p. 41):
f f 1 2f
df (Bt , t) = (Bt , t)dBt + (Bt , t)dt + (Bt , t)dt
x t 2 x2
ext/2 2 ext/2 ext/2
Since x
= ext/2 , x2
= ext/2 and t
= 21 ext/2 , we have
1 1
d(eBt t/2 ) = eBt t/2 dBt eBt t/2 dt + eBt t/2 dt = eBt t/2 dBt
2 2
Z t
eBt t/2 = 1 + eBs s/2 dBs
0
8. Solve SDE
dXt = Xt dt + dBt , X0 = 1
Solution
This is the Ornstein-Uhlenbeck process. Use transformation Yt = Xt et and
the product rule (Section 9.5, p. 42)
Hence,
Z t
Yt = Y0 + es dBs
0
Z t
Xt et = 1 + es dBs
0
Z t
Xt = et + et es dBs
0