The Annals of Applied Probability

Mimicking an Itô process by a solution of a stochastic differential equation

Gerard Brunick and Steven Shreve

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Abstract

Given a multi-dimensional Itô process whose drift and diffusion terms are adapted processes, we construct a weak solution to a stochastic differential equation that matches the distribution of the Itô process at each fixed time. Moreover, we show how to match the distributions at each fixed time of functionals of the Itô process, including the running maximum and running average of one of the components of the process. A consequence of this result is that a wide variety of exotic derivative securities have the same prices when the underlying asset price is modeled by the original Itô process or the mimicking process that solves the stochastic differential equation.

Article information

Source
Ann. Appl. Probab., Volume 23, Number 4 (2013), 1584-1628.

Dates
First available in Project Euclid: 21 June 2013

Permanent link to this document
https://projecteuclid.org/euclid.aoap/1371834039

Digital Object Identifier
doi:10.1214/12-AAP881

Mathematical Reviews number (MathSciNet)
MR3098443

Zentralblatt MATH identifier
1284.60109

Subjects
Primary: 60G99: None of the above, but in this section 60H10: Stochastic ordinary differential equations [See also 34F05] 91G20: Derivative securities

Keywords
Itô process stochastic differential equation derivative security pricing stochastic volatility models

Citation

Brunick, Gerard; Shreve, Steven. Mimicking an Itô process by a solution of a stochastic differential equation. Ann. Appl. Probab. 23 (2013), no. 4, 1584--1628. doi:10.1214/12-AAP881. https://projecteuclid.org/euclid.aoap/1371834039


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