Lévy processes

Abhinav Pradeep

March 19, 2024

Table of Contents

Lévy process

Algorithm to simulate a Lévy process

Recap: Brownian motion

Recap: Poisson random measure

Recap: Poisson process and compound Poisson process

Lévy–Itô decomposition

Characterising a Lévy process

Gamma process

Simulation
Lévy process

A Lévy process is a stochastic process {Xt }R , Xt ∼ Dist(t)

satisfying

1. Continuity conditions: Right continuous and left limited.

2. Independent increments: ∀ t1 < t2 < t3 < t4 ∈ R,

Xt4 − Xt3 independent of Xt2 − Xt1

and stationary increments:

∀t, n ∈ R (Xt+n − Xt ) ∼ Dist(n)

The Lévy process hence generalises of properties of the Wiener and
compound Poisson processes. An interesting property is that it can
be fully characterised by a PRM and Brownian motion.
Algorithm to simulate a Lévy process

This algorithm exploits the independent and stationary nature of

increments.

Given that the marginal distributions Xt ∼ Dist(t) is known ∀t.

Generating a over interval [0, tn ] can be done by:

1. Set X0 := 0. Take k = 1

2. Draw A ∼ Dist(tk − tk−1 )

3. Set Xk = Xk−1 + A

4. While k ̸= n, set k := k + 1 and repeat steps 2 and 3.

Recap: Brownian motion

A Wiener process Wt is a Gaussian process with continuous sample

paths on R+ s.t. µ({Wt }R+ ) = 0 and Cov(Ws , Wt ) = s ∧ t.

A Brownian motion is obtained by applying an affine

transformation to the Wiener process:

Bt>0 := B0 + at + cWt
Where a ∈ R is called the drift coefficient and c ∈ R is called the
diffusion coefficient. Moreover, B0 is Gaussian and independent of
{Wt }R+ .

Effectively it is some intensity of a Wiener process that moves in

some direction starting at some random point such that the start
point says noting about future movement.
Recap: Poisson random measure

Consider measurable spaces (Ω, H) and (E , E). A random measure

is a mapping N : Ω × E → R+ such that NA (ω) : ω 7→ N(ω, A) is
a random variable and ∀A ∈ E, Nω (A) : A 7→ N(ω, A) is a measure
on (E , E).

Let E ⊆ Rn and E := B(E ). A Poisson random measure is a

random counting measure on (E , E) such that:

N(ω, A) ∼ Poi(µ(A))
Where µ is called the mean measure and for any disjoint sequence
of sets An the random variables NAn (ω) are independent.
Recap: Poisson process and compound Poisson process

Setting E := R+ and E correspondingly the Poisson process Nt is

defined as:
Nt := N[0, t]
Now set E := R+ × Rn . Suppose a product measure of Leb ⊗ ν.
Suppose ν(Rn ) = c < ∞. That is the number of points scattered
along Rn is finite and on average equal to c. The process

Kt := N([0, t] × Rn )
With mean measure Leb ⊗ ν is a Poisson process. A compound
Poisson process is the below stochastic integral taken w.r.t. the
measure defined by N:
Z
Xt≥0 := xN(ds, dx)
[0,t]×Rn
Recap: Compound Poisson process

Z
Xt≥0 := xN(ds, dx)
[0,t]×Rn

Where the above integral is effectively adding up the values of the

scattered points across Rn for each arrival ∈ [0, t]. That is, the
above process can be thought of as: for any number of arrivals
Kt ∼ Poi(ct) on [0, t] we add the batch of summed up points
Y ∼ νc . That is:
Kt
X
Xt≥0 = Yi
i=1
i.i.d ν
∼ c
Where Y1 , Y2 , Y3 . . . independently of Poisson counting
process Kt with rate c.
Lévy–Itô decomposition

Recall the condition (call it 1.0) for compound Poisson process:

ν(Rn ) := c < ∞

This can be relaxed to (call it 2.0):

Z
min (∥x∥, 1)ν(dx) < ∞
Rn

and further relaxed to (call it 3.0):

Z
min (∥x∥2 , 1)ν(dx) < ∞
Rn
Lévy–Itô decomposition
Theorem: A process is Lévy taking values in Rn ⇐⇒ it can be
written as a sum:

Xt = bt + cWt
Z
+ xN(ds, dx)
[0,t]×{∥x∥>1}
Z
+ lim x[N(ds, dx) − dsν(dx)]
δ↓0 [0,t]×{δ≤∥x∥≤1}

The first part is just a 0 mean Brownian motion with drift

coefficient b ∈ Rn and diffusion coefficient c ∈ Mn×m (R) with Wt
having state space Rm . The second component is a compound
Poisson process over R+ × Rn with Rn endowed with measure ν
satisfying the Condition 3.0. The final term is a compensated
Poisson processes, designed to handle the singularities encountered
when extending previous term to include the unit ball.
Lévy–Itô decomposition

Consider specifically the compensated Poisson process. Let:

Z
δ
lim Xt := lim x[N(ds, dx) − dsν(dx)]
δ↓0 δ↓0 [0,t]×{δ≤∥x∥≤1}

The claim is that

lim Xtδ := Xt
δ↓0

Almost surely where Xt is some Lévy process. Convergence almost

surely is analogous to µ-almost convergence for µ-measurable
functions over some (E , E, µ). Specifically, the condition can be
stated as:

P({ω | lim Xtδ := Xt }) = 1

δ↓0
Lévy–Itô decomposition

To get an intuition of this consider that:

Z Z
Xtδ := xN(ds, dx) − xdsν(dx)
[0,t]×{δ≤∥x∥≤1} [0,t]×{δ≤∥x∥≤1}

And by Fubini’s
Z Z !
Xtδ := xN(ds, dx) − xν(dx) t
[0,t]×{δ≤∥x∥≤1} {δ≤∥x∥≤1}

Denote Z
Ytδ := xN(ds, dx)
[0,t]×{δ≤∥x∥≤1}
Z
δ
a := xν(dx)
{δ≤∥x∥≤1}
Lévy–Itô decomposition

Hence we write:
Xtδ := Ytδ − aδ t
Now consider two weakened cases:

Condition 2.0 holds without 1.0: The clearly limδ↓0 Ytδ = Yt is

going to exist and by linearity can be added back to the prior term.
This just leaves the drift term which limδ↓0 aδ := a < ∞ by 2.0
and hence adds −at to the process. Hence Xt is just a Poisson
process with drift given by a ∈ Rn .

Only Condition 3.0 holds: limδ↓0 Ytδ → ∞ and limδ↓0 aδ → ∞.

However, the singularities cancel out to some Xt such that it has
infinite variation over every interval (s, t) (Cinlar, 2011).
Characterising a Lévy process

A corollary of Lévy–Itô decomposition is that the characteristic

function of a Lévy process Xt :

ψ(r) = Ee i⟨r,Xt ⟩
Has exponent
1
= ⟨r, Σr⟩ + i⟨r, b⟩
2 Z
e i<r,x> − 1 ν(dx)


+
∥x∥>1
Z
e i<r,x> − 1 − i⟨r, x⟩ ν(dx)


+
∥x∥≤1

Hence the triplet (b, Σ, ν) completely characterizes Xt with

Σ = c T c.
Gamma process
A Gamma process with state-space R+ is a Lévy process
R1 such that
it has no Wiener process component, has drift a = 0 xν(dx) and
its Poisson random measure N(ds, dx) has mean measure

ds ν(dx) := ds g (x)dx
With (for some α, λ ∈ R+ ):

αe −λx
g (x) :=
x
Hence, it has characteristic triplet (a, 0, ν). Clearly ν does not
satisfy Condition 1. That is:
Z
ν(R+ ) = 1ν(dx)
R+
Z
= g (x)dx
R+
Gamma process

αe −λx
Z
= dx → ∞
R+ x
However, it does satisfy Condition 2:

αe −λx 1
1 − e −λ
Z Z  
−λx
x· ⇒ αe := α <∞
{x≤1} x 0 λ
and
∞
αe −λx αe −λx
Z Z
⇒ dx < ∞
{x>1} x 1 x
Hence the process can be written as:

Z 1  Z Z 1 
Xt := xν(dx) t + xN(ds, dx) − xν(dx) t
0 [0,t]×R+ 0
Gamma process
Clearly, the drift terms cancel out leaving the pure jump Levy
process:
Z
Xt := xN(ds, dx)
[0,t]×R+

To determine the marginal distributions, consider the exponent of

the characteristic function:
Z ∞ 
=t e i(rx) − 1 ν(dx)
0
Z ∞  αe −λx
=t e i(rx) − 1 dx
0 x
 α  αt
λ λ
= t ln = ln
λ − ir λ − ir
Hence, the marginal distributions are Xt ∼ Gamma(αt, λ)
Gamma process
Moreover, the distribution of the increments can be determined by
observing the characteristic function of the difference Xt+δ − Xt :

Z ∞  Z ∞ 
i(rx)
= (t + δ) e − 1 ν(dx) − t e i(rx) − 1 ν(dx)
0 0
Z ∞ 
=δ e i(rx) − 1 ν(dx)
0
And by prior derivations,
 αδ
λ
= ln
λ − ir

Hence, Xt+δ − Xt ∼ Gamma(αδ, λ) and the marginal distributions

of the gamma process are fully characterized.
MATLAB code for the simulation
n = 100; % Number of steps
t = linspace(0, 1, n+1); % Time vector from 0 to 1, divided into n intervals
% Define parameters of gamma distribution
alpha = 2;
lambda = 1;

% Initialize array tracking the realization

X = zeros(1, n+1);
% Set X_0 to 0. Matlab arrays not zero indexed.
X(1) = 0;

% Loop as was previously described

for k = 2:n+1
delta_t = t(k) - t(k-1);
% Generate increment
A = gamrnd(alpha*delta_t, lambda);
% Add increment
X(k) = X(k-1) + A;
end

% Plot
plot(t, X);
xlabel(’Time’);
ylabel(’X(t)’);
title(’Realization of a Gamma Process’);
Example realisation
Citations

Course textbook

Cinlar, E. (2011) Probability and stochastics. New York: Springer.