COLLABORATIVE REVIEW FOR MODULE #2

Let W={Wt:t≥0) be a Brownian Motion on (Ω, F , F = (Ft )t≥0 , P). Fix α,

β∈R and consider the following Stochastic Differential
Equation (SDE):
𝛽−𝑋𝑡
dXt = 𝑑𝑡 +dWt , 0<t<T and X0 =α, XT =β
𝑇−𝑡

A solution to this SDE, with the given boundary

conditions is called a Brownian bridge. By applying the
𝑋𝑡
Ito’s Lemma to Yt :=f(t, Xt ) = 𝑇−𝑡
, solve this SDE and find

the distribution, mean and variance of X t , where 0<t<T.

Solution:

𝑋𝑡
Yt :=f(t,Xt )= 𝑇−𝑡

∫𝑡=0 𝑑𝑋𝑡 =XT-Xt≈

𝑇
= N(t,T)

𝑇 𝑇 𝑇
=∫𝑡=0 𝑑𝑋𝑡 =∫𝑡=0 µ𝑠 𝑑𝑡 + ∫𝑡=0 𝛼𝑠 𝑑𝑊𝑡

=E0(XT-Xt)=µT and 𝜎 2 (XT-X0)= 𝜎 2 T

𝑇 𝑑𝑋𝑇
=∫𝑡=0
𝑑𝑋𝑡

𝑇
=∫𝑡=0
𝑇
𝑑𝑙𝑜𝑔𝑋𝑜
1
=(µ-2 𝜎 2 ) ∫𝑡=0 𝑑𝑋𝑇 + 𝜎 ∫𝑇=0 𝑑𝑡
1 𝑡
=logXT - logXt =(𝜇 - 𝜎 2 )T + 𝜎 ∫𝑇=0 𝑑𝑡
2
1
𝑋𝑡 (𝜇− 𝜎 2 ) 𝑇
= =𝑒 2 T + 𝜎 ∫𝑇=0 𝑑𝑥𝑡
𝑋0
 1
𝑋𝑇 (𝜇− 𝜎 2 ) 1
Eo( )=𝑒 2 T + 𝜎2
𝑋𝑡 2

Note:
a) The distribution is normal with intervals 0<t<T
1
(𝜇− 𝜎 2 )
b) Mean = 𝑒 2 T
1
c) Variance =𝑒 𝜇 + 𝜎2
2