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Tutorial 4 Black Karasinski PDF

This tutorial provides an analytical solution for the Black-Karasinski (i.e. BK) stochastic differential equation. We start by expressing the stochastic process followed by the natural logarithm of i1 noted ln(i1 ) as the sum of two components.

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266 views2 pages

Tutorial 4 Black Karasinski PDF

This tutorial provides an analytical solution for the Black-Karasinski (i.e. BK) stochastic differential equation. We start by expressing the stochastic process followed by the natural logarithm of i1 noted ln(i1 ) as the sum of two components.

Uploaded by

stehbar9570
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Black-Karasinski Process

This tutorial provides an analytical solution for the Black-Karasinski (i.e. BK) stochastic differential equation.

We start by expressing the stochastic process followed by the natural logarithm of noted ln( ) as the sum of

two components. The first one is considered to be totally predictable depending on time, and the second one is a

diffusion stochastic process. To be precise, the stochastic differential equation for ln( ) is:
( ) = ( l n( )) +

, ,

Note that ( ) is the natural filtration of the Brownian motion .


Let's use It's lemma1 by defining the function f:

= () = (ln( ))

1
(ln( )) = = (ln( )) ( ) + (ln( ))
2
1
= ( ) ( ) + ()
2

1
= ( ( ln( )) + +
2
1

= ( ( ln( )) + +

An explicit solution can be found with the OrnsteinUhlenbeck process2

= ln( ) + () + ()

= ln( ) + (1 ) + ()

Therefore, is log normally distributed3 with first and second moments given respectively by:

= ln( ) + (1 ) exp ( () )

By using Laplace:

1
exp ( () ) = () + ()
2

Or: () ) = 0

because: ( () ) ) < (stochastic integral)

Consequently:

exp (

()

1
) = ()
2

With:

Ito's lemma is a theorem in stochastic calculus.


See Tutorial 2: OrnsteinUhlenbeck Process.
3
See Tutorial 1: Log Normal Distribution.
2

-1-

() = ( () )

Moreover:

( () ) = ()

(stochastic integral definition)

Hence:

1
1
1 .

exp ( () ) = () =
= (1 )
2
2
2
4

Finally, we can write:


= ln( ) + (1 ) +

(1 )
4

By using the same process:


( ) = 2 ln( ) + 2(1 ) +
= ( )

(1 )

= 2 ln( ) + 2(1 ) (1 ) (1 )

-2-

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