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    Midterm 2019

    Uploaded by

    Uasdaf
    This document outlines the topics and questions for a stochastic calculus midterm exam, including: 1) Calculating the probability a fund manager is skilled based on past returns. 2) Showing a stochastic process is Markov and calculating expectations and variances. 3) Deriving distributions from stochastic differential equations. 4) Properties of moment generating functions and how they transform for linear combinations of random variables.

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    Midterm 2019

    Uploaded by

    Uasdaf
    17 views2 pages
    This document outlines the topics and questions for a stochastic calculus midterm exam, including: 1) Calculating the probability a fund manager is skilled based on past returns. 2) Showing a stochastic process is Markov and calculating expectations and variances. 3) Deriving distributions from stochastic differential equations. 4) Properties of moment generating functions and how they transform for linear combinations of random variables.

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    This document outlines the topics and questions for a stochastic calculus midterm exam, including: 1) Calculating the probability a fund manager is skilled based on past returns. 2) Showing a stochastic process is Markov and calculating expectations and variances. 3) Deriving distributions from stochastic differential equations. 4) Properties of moment generating functions and how they transform for linear combinations of random variables.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    17 views2 pages

    Midterm 2019

    Uploaded by

    Uasdaf
    This document outlines the topics and questions for a stochastic calculus midterm exam, including: 1) Calculating the probability a fund manager is skilled based on past returns. 2) Showing a stochastic process is Markov and calculating expectations and variances. 3) Deriving distributions from stochastic differential equations. 4) Properties of moment generating functions and how they transform for linear combinations of random variables.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 2

    Stochastic Calculus

    Midterm exam
    Prof. D. Filipović, E. Hapnes
    29.10.2019

    Time: 9:15-12:00. Full credit is for the correct answer and explanation.
    Exercise 1: A fund manager can be skilled (S = H) or unskilled (S = L). If the fund manager
    is skilled, then the return of her fund is good, RG , with probability q > 12 and bad, RB , with
    probability 1 − q. If the fund manager is unskilled, then the return is RG with probability
    1 − q and RB with probability q. Your prior belief is P rob(S = H) = 12 . Define Pn (m) as the
    probability that the fund manager is skilled if you have n observations where the return is RG
    in m of them.

    (a) Find an expression for Pn (m).

    (b) Define the random variable M , which takes the values M = 0, 1, ..., n, as the number of
    times you observe the return RG . For n = 1, show that E[P1 (M )|S = H] > 21 .

    (c) Calculate E[P1 (M )].


    q
    Hint: Find your solutions in terms of ρ = (1−q)
    .

    10 points

    Exercise 2: Let Xt and Yt for t = 1, 2, ... be sequences of independent and identically dis-
    2
    tributed random variables with means µX and µY , and variances σX and σY2 . Consider the
    stochastic process
    Zt = Y1 X1 + Y2 X2 + · · · + Yt−1 Xt−1 + Yt Xt .

    (a) Show that Zt is a Markov process.

    (b) Calculate E[Zt+1 |Zt ] and V ar(Zt+1 |Zt ).

    10 points
    Exercise 3: Let St have the dynamics

    dSt = µSt dt + σSt dWt

    where Wt is a Brownian motion, S0 = s > 0, and µ and σ > 0 are constants.

    (a) Calculate d log(St ).

    (b) Show that the distribution of log(St ) is normal. What is its mean and variance?

    (c) Calculate E[1{St ≥K} ] for some constant K > 0. Here, 1{St ≥K} is an indicator function that
    takes the value 1 when St ≥ K and 0 otherwise.

    10 points

    Exercise 4: Let X be a random variable with mean µ and moment generating function MX (t).

    (a) Show that:

    • MX (t) ≥ eµt .
    • P (X ≥ α) ≤ e−αt MX (t) for 0 ≤ t and any α as long as the moment generating
    function exists.

    (b) Let Y = a + bX. Calculate the moment generating function of Y as a function of the
    moment generating function of X and the parameters a and b.

    (c) Let X ∼ N (0, 1) and Y = X 2 . Calculate the moment generating function of Y , and
    evaluate E[Y ] and V ar(Y ).

    10 points

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