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Final Cheat Sheet

The document provides key concepts and formulas related to stochastic calculus, including Ito's lemma, product and quotient rules, the Feynman-Kac theorem, and martingale representation. It outlines the mathematical expressions and conditions necessary for applying these concepts in financial mathematics. Additionally, it discusses Novikov's condition and Girsanov's theorem in the context of martingales and Brownian motion.

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zzyyuan06
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14 views4 pages

Final Cheat Sheet

The document provides key concepts and formulas related to stochastic calculus, including Ito's lemma, product and quotient rules, the Feynman-Kac theorem, and martingale representation. It outlines the mathematical expressions and conditions necessary for applying these concepts in financial mathematics. Additionally, it discusses Novikov's condition and Girsanov's theorem in the context of martingales and Brownian motion.

Uploaded by

zzyyuan06
Copyright
© © All Rights Reserved
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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Final Exam Cheat Sheet

1. Ito’s lemma

Ito’s Lemma for scalars: If g : R+ × R → R is twice continuously differ-


entiable, then for
dXt = µ(t, Xt )dt + σ(t, Xt )dBt ,

we have that

∂ 2 g(t, Xt )
 
∂g(t, Xt ) ∂g(t, Xt ) 1 2
dg(t, Xt ) = + µ(t, Xt ) + σ (t, Xt ) dt
∂t ∂Xt 2 ∂Xt2
∂g(t, Xt )
+ σ(t, Xt ) dBt .
∂Xt

Or suppressing the arguments of g

∂ 2g
 
∂g ∂g 1 2 ∂g
dg = + µ(t, Xt ) + σ (t, Xt ) 2
dt + σ(t, Xt ) dBt .
∂t ∂Xt 2 ∂Xt ∂Xt

1
2. Product and quotient rules

Suppose there are two processes, both driven by the same Brownian mo-
tion:

dXt =µx (t)dt + σx (t)dBt


dYt =µy (t)dt + σy (t)dBt .

The Product Rule:


d Xt Yt = Xt dYt + Yt dXt + dXt · dYt
= Xt dYt + Yt dXt + σx (t)σy (t)dt,

The Quotient Rule:

Xt  Xt h dXt dYt dXt dYt  dYt 2 i


d = − − +
Yt Yt Xt Yt Xt Yt Yt

2
3. Feynman-Kac Theorem

∂f
Feynman-Kac formula: If f is twice continuously differentiable, ∂x
is
bounded and f satisfies the partial differential equation (for all t, x)
1
ft (t, x) + fx (t, x) µ (t, x) + σ 2 (t, x) fxx (t, x) = r (x, t) f (x, t)
2
with boundary condition f (x, T ) = g (x), then
h RT i
f (t, x) = EtQ e− t r(Xs ,s)ds g (XT ) |Xt = x ,

where Xt solves
dXt = µ(t, Xt )dt + σ(t, Xt )dBtQ ,

3
4. Martingale representation, Novikov and Girsanov

ˆ Martingale Representation If Mt is a martingale on (Ft , P), then


there exists a square-integrable ηt such that
Z t
Mt = M0 + ηs dBsP .
0

ˆ Novikov A process ηt satisfies Novikov’s condition if


  Z T 
1 2
E exp η dt < ∞.
2 0 t

ˆ If ηt satisfies Novikov’s condition, then


 Z t
1 t 2
Z 
Zt = exp − ηs dBs −
P
η ds
0 2 0 s

is a (Ft , P) martingale.

ˆ Girsanov Given a square-integrable ηt , suppose that Lt is a martin-


gale. Then Z t
BtQ = BtP + ηs ds
0

is a standard Brownian motion defined on (Ω, F, Q). Moreover, for


any Q martingale, there exists a square-integrable ϕs such that any
Rt
martingale Mt can be represented as Mt = M0 + 0 ϕs dBsQ .

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