Stochastic Calculus II

Exercise Sheet 11
Prof. D. Filipović, E. Hapnes

Please hand in your solutions to exercises 2 and 3 on Wednesday 23.5.2018 at the

beginning of the lecture.

Exercise 1:

(i) Prove that the exponential distribution is memoryless, i.e. for every t > 0 and s > 0

P(τ > t + s| τ > t) = P(τ > s)

where τ ∼ Exp(λ).

(ii) Let τ1 , τ2 , . . . ∼ Exp(λ) be independent and identically distributed (i.i.d.) random vari-
ables. Define n
X
Sn , τl . (1)
l=1

Prove that the density of Sn is given by

(λs)n−1 −λs
gn (s) = λe .
(n − 1)!

(iii) Let τ1 , τ2 , . . . ∼ Exp(λ) be i.i.d. random variables and Sn given by (1). A Poisson process
with intensity λ is defined by
∞
X
Ns , ISn ≤s , s ≥ 0.
n=1

Let t ≥ 0 be fixed and set

n(t) , inf{n ≥ 0 : Sn > t}
and
Z1 , Sn(t) − t and Zk , Sn(t)+k−1 − Sn(t)+k−2 for k ≥ 2.

(a) Prove that P(Z1 ≥ z | Nt ) = e−λz for z ≥ 0.

(b) Prove that Z1 , Z2 , . . . ∼ Exp(λ) are i.i.d. and independent of Nt .
(c) Discuss why the sequence {Zk }k≥1 is independent of {Ns }0≤s≤t .
(d) Conclude that {Nt+s −Nt }s≥0 is a Poisson process with intensity λ that is independent
of {Ns }0≤s≤t .
Assignment
Exercise 2: Consider the Black-Scholes economy where the risky asset has the risk-neutral
dynamics

dSt = rSt dt + σSt dWt .

The goal of this exercise is to calculate the amount invested in the risky asset, ut , in a replicating
portfolio of a derivative with the payoff F (ST ) with the Clark-Ocone formula. From the Clark-
Ocone formula in the Black-Scholes economy we can write a function F (ST ) as
Z T
F (ST ) = E[F (ST )|St ] + f (u, Su )σSu dWu (2)
t
r(T −t) 0
where f (t, x) = E[e F (YT )|Yt = x] and dYt = (r − σ 2 )Yt dt + σYt dWt .(Exercise sheet 9,
exercise 1.)

(a) Let Xt be the value of a self-financing portfolio with a fraction πt or a total amount
ut = πt Xt in the risky asset. Find the value of a self-replicating portfolio at time t in terms
of ut .

(b) Consider a derivative with the discounted payoff e−r(T −t) F (ST ). Use the Clark-Ocone
formula to find an expression for the discounted payoff and compare it with the expression
for a self-financing portfolio. What amount of the risky asset do you hold at time t?

(c) Find the amount of the risky asset at time t necessary to replicate a European call-option.

5 points

Exercise 3: Consider a Poisson process N . Taking into account that {Nt+s − Nt }s≥0 is
independent of {Ns }0≤s≤t , show that

(a) Mt , Nt − λt, t ≥ 0 is a martingale with respect to the filtration generated by N .

(b) Mt2 − λt, t ≥ 0 is a martingale with respect to the filtration generated by N .

(c) Let
St , exp (Nt log(σ + 1) − λσt) = (σ + 1)Nt e−λσt
 
for some parameter σ > −1. Compute E Sr − St | {Ns }0≤s≤t for r > t. Conclude that St
is a martingale with respect to the filtration generated by N .

5 points