Stochastic Calculus II

Exercise Sheet 9
Prof. D. Filipović, E. Hapnes

Please hand in your solutions to exercises 2 and 3 on Wednesday 9.5.2018 at the

beginning of the lecture.

1 Classroom exercise
Exercise 1: Let Xt have the dynamics

dXt = µ(Xt ) dt + σ(Xt ) dBt .

By the Ito representation theorem,

Z T
F (XT ) = E[F (XT )] + ft dBt
0
for some ft . The goal of this exercise is to find ft . This is known as the Clark-Ocone
formula.

(a) Define u(t, x) = E[F (XT )|Xt = x]. Write down the general solution for u(T, XT ) and find
a PDE for u(t, x).
∂u(t,x)
(b) Define v(t, x) = ∂x
. Differentiate the PDE from above with respect to x and find a PDE
for v(t, x).

(c) Solve the PDE for v(t, x) and use the solution to get an expression for ft .

Assignment
Exercise 2: In each of the cases below find the process f (t, ω) such that
Z T
F (ω) = E[F ] + f (t, ω)dBt .
0

(a) F (ω) = BT (ω)

(b) F (ω) = BT2 (ω)

RT
(c) F (ω) = 0 Bt (ω) dt

(d) F (ω) = eBT (ω)

5 points
Exercise 3: Consider a general control problem of maximising
Z T 
u u
E F (t, Xt , ut ) dt + Φ(XT )
0

given the dynamics

dXt = µ(t, Xt , ut ) dt + σ(t, Xt , ut ) dWt .
As usual we assume that this control problem has a solution and we denote by V (t, x) the
optimal value function. For any control law u we define the process
Z t
C(t; u) = F (s, Xsu , us ) ds + V (t, Xtu ), t ∈ [0, T ].
0

Use the HJB equation in order to prove the following claims:

a) If u is an arbitrary control law, then C(·; u) is a supermartingale.

b) The control law u is optimal if and only if C(·; u) is a martingale.

5 points