Zacharia Maganga Nyambu-Worldquant University Student

Louis Jean-Baptiste Alphonse Bachelier

Is recognised by his work, model the stochastic process now called Brownian motion for his PhD thesis The
Theory of Speculation (Théorie de la spéculation, published 1900). He was a pioneer in mathematical finance.
He influenced other scholars like Benoit Mandelbrot, Fischer Black, Myron Scholes and Paul Samuelson that
lead to leading to the Nobel Prize-winning solution of the option pricing problem in 1973. Bachelier’s work was
not important until it was taken up by Paul Samuelson in the 1960s as the mathematics was not developed
towards economic applications but eventually led to black-scholes model. training in probability and the
theory of heat, combined with hands-on knowledge of the stock exchange, provided Bachelier with the tools
that he needed to write his remarkable thesis. Precisely this combination of mathematical ideas lays the
foundation for the modern theory of Brownian motion. Bachelier is generally now credited wi th being the first
to introduce this mathematical process, but there are earlier claims. Bachelier’s Brownian motion initial
thought came from the model of the fluctuations in stock prices. He stated that the small fluctuations in price
seen over a short time interval should be independent of the current value of the price.

Bachelier provided two different derivations of the partial differential equation for the probability density
of what later was called a Wiener process or Brownian motion process. In one derivation, he wrote an
integral commonly called the Chapman-Kolmogorov convolution probability integral in one of the earliest
examples of that integral. In the other, he uses a limit argument applied to a di screte-time binomial
process to derive the continuous-time transition probabilities.

Random walk a financial theory stating that stock market prices changes are random. This was an efficient-
market hypothesis came up by a broker Jules Regnault who published a book in 1863, and then to French
mathematician Louis Bachelier whose Ph.D. dissertation. A MODERN view of random walk is that past price
changes cannot forecast future price changes. However perhaps other information like news, sales, earnings,
interest rate, dividends etc. past price changes does permit the forecasting of future price changes thus
perhaps the market is not efficient, even though the stock price does follow a random walk.

The probabilistic model that In 1900, Luis Bachelier in his Ph.D. thesis Theorie de la speculation described

the behaviour of the stock exchange in Paris and showed a stochastic process , defined
in continuous time as;

For 0 s t, the increments are stochastically independent over disjoint intervals,

and have Gaussian distribution with 0 mean and variance (t s)

For (P-almost) all the trajectory is continuous.

In 1905 Einstein introduced the very same mathematical model and results which he explain the thermal
motion of pollen particles suspended in a liquid Concerning the motion, as required by the molecular-kinetic
theory of heat, of particles suspended in liquids at rest, which had been observed by the botanist Brown.
Einstein’s theory was based on a Markov chain model for the motion of the particle. The derivation of the
Fokker-Planck equation from the Chapman-Kolmogorov equation through a Kramers-Moyal expansion.

Is called Brownian motion or Wiener process, after Norbert Wiener who started the theory of stochastic
integration also denoted as.

To honour of Bachelier we to use the notation.

Paul Samuelson represented prices as stochastic processes and computed the quantities of interest by
exploiting the connection between these processes and partial differential equations. He based his argument
 Zacharia Maganga Nyambu-Worldquant University Student

on a martingale assumption, which he justified on economic grounds. Samuelson immediately recognized that
this was the way to go. And the tools were in much better shape than those available to Bachelier. Samuelson
used similar tools to Bachelier who looked at the option pricing problem, and come up with a formula
extremely close to the Black–Scholes formula of seventy years later using the methods of what was later called
stochastic analysis.

Kiyosi Itô

An award to Kiyosi Ito Gauss Prize 2006 for Applications of Mathematics on laying foundations of the theory of
Stochastic Differential Equations and Stochasti c Analysis. He worked on the theory of a Markov process which
he published in the paper Differential equations determining a Markov process in 1942.

A Markov process is usually described in terms of the transition probabilities P t(x,A) which specify, for each
state x and any time t ≥ 0,the probability of fi nding the process at time t in some subset A of the state space,
given that x is the initial state at time 0, these transition probabilities should satisfy the Chapman-Kolmogorov
equations.

Kiyosi Itô had introduced the stochastic integral , it was clear how to define a solution of the stochastic
differential equation, in order to prove the existence of the solution, Itô used a stochastic version of the
method of successive approximation, having first clarified the dynamic properties of stochastic integrals
viewed as stochastic processes with time parameter t. The role of straight lines is taken by processes whose
increments are independent and i dentically distributed over time intervals of the same length, such processes
are named in honour of Paul Levy. Kiyosi Itô had already investigated in depth the path wise behaviour of Levy
processes by proving what is now known as the Levy-Itô decomposition. In the continuous case and in
dimension d = 1, the prototype of such a Levy process is a Brownian motion with constant drift, whose
increments have a Gaussian distribution with mean a nd variance proportional to the length of the time
interval(). The significance of this is that it was earlier introduced by Louis Bachelier

Itô's formula

An extension of differential equation.

J.L. Doob recognised the importance of Kiyosi Ito work in a Stochastic Differential Equations in 1951

It was in 1944 that Kyoshi Ito extended Wiener integral to the class of non-anticipative integrand processes.
This was the beginning of modern stochastic analysis.

Kiyosi Itô's contributions in the field of quantitative finance has been transformed by Itô's calculus, not
limited to this applications of Markov process and stochastic integrals have been used outside of mathematics
as illustrated by him working with Salomon Bochner and William Feller at Princeton university as a fellow in
1954 on diffusion theory specifically on general structure of one-dimensional diffusions with local generator.

By introducing stochastic differential equations and Itô's lemma we will be able to define Itô's integral and
follow up on more of his contributions that helps understand financial derivative of a stock. Ito's lemma
provides a way to construct new SDE's from given ones. It is the stochastic calculus counterpart of the chain
 Zacharia Maganga Nyambu-Worldquant University Student

rule in calculus. It can be understood by considering a Taylor series expansion and understanding how it should
be modified in this stochastic setting (Whitt,2007).

Paul-André Meyer

MEYER reviews the history of the theory of stochastic processes from1950 into the 1990s he shows the
importance of martingales. The progress accomplished in fifty years responds to the increasing role of
probability in scientific thought in general, and finds its justification in more powerful methods of calculation,
which allow us for example to consider the measure associated with a stochastic process as a
whole(Meyer,2009).

“The first step of their development, after Doob had exhibited their power, was the generalization, in the
1950s, of Ito's stochastic integration for Brownian motion. The martingale property, generalized in several
directions, especially in the concepts of local martingale and semi martingale, emerged as the fundamental
property required for stochastic integration and stochastic differential equations. The second step, in which
MEYER and his seminar at Strasbourg were central, was the general theory of processes that emerged in
the1960s. It demonstrated both the generality of many ideas that had first been developed for Markov
processes and the role of martingales in very general representations of stochastic processes ”

He recognised Kiyosi Itô's early work on and other Japanese contributions by hel ping us understand of
diffusion martingale techniques. He showed the emergence of martingales using sequential analysis.

He explained Markov processes using three theories markov chains, random walks and Brownian motion
which are process with independent increments .
 Zacharia Maganga Nyambu-Worldquant University Student

References

1. Helyette Geman,Dilip Madan, Stanley R. Pliska,Ton Vorst(2000). Selected Papers from the First World
Congress of the Bachelier Finance Society, Paris, June 29-July 1,2000. Mathematical Finance -
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Bachelier Congress. (Accessed on 10 September 2018)
2. Paul-André Meyer(2009).Journal électronique d’Histoire des Probabilities et de la Statistique/
Electronic Journal for History of Probability and Statistics . Vol.5, n°1. Juin/June 2009 . (Accessed on
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10 September 2018)
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3. Lino Sant. STOCHASTIC DIFFERENTIAL EQUATIONS WITH JUMPS. (Accessed on 10 September 2018)
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4. Mark H. A. Davis. Louis Bachelier’s “Theory of Speculation”. (Accessed on 10 September 2018)
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MATHEMATICS STUDIES. (Accessed on 10 September 2018)
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Development of Mathematics 1950–2000, (Accessed on 10 September 2018)