2.

1 Description of the Model 13

The interpretation goes as follows. By changing the portfolio from H  t−1


to Ht there is no input/outflow of money. We remark that we assume that
 tj may
changing a portfolio does not trigger transaction costs. Also note that H
assume negative values, which corresponds to short selling asset j during the
time interval ]tj−1 , tj ].
The Ft -measurable random variable defined in (2.1) is interpreted as the

value Vt of the portfolio at time t defined by the trading strategy H:

Vt = (H
 t , St ) = (H
 t+1 , St ).

The way in which the value (H  t , St ) evolves can be described much easier
when we use discounted prices using the asset S0 as numéraire. Discounting
allows us to compare money at time t to money at time 0. For instance we
could say that St0 units of money at time t are the “same” as 1 unit of money,
e.g., Euros, at time 0.So let us see whathappens if we replace prices S by
  0 1 d
discounted prices SS0 = SS 0 , SS 0 , . . . , SS 0 . We will use the notation

Stj
Stj := , for j = 1, . . . , d and t = 0, . . . , T. (2.3)
S0
t

There is no need to include the coordinate 0, since obviously St0 = 1. Let us

now consider (H  t0 , H
 t )Tt=1 = (H  t1 , . . . , H
 td )Tt=1 to be a self financing strategy
with initial investment V0 ; we then have


d 
d 
d
V0 =  j Sj = H
H 1 0
0 +
1
 j Sj = H
H 1 0
0 +
1
 j Sj,
H 1 0
j=0 j=1 j=1

since by definition S00 = 1.

We now write (Ht )Tt=1 = (Ht1 , . . . , Htd )Tt=1 for the Rd -valued process ob-
tained by discarding the 0’th coordinate of the Rd+1 -valued process (H  t )Tt=1 =
 0 1  d T j  j
(Ht , Ht , . . . , Ht )t=1 , i.e., Ht = Ht for j = 1, . . . , d. The reason for dropping
the 0’th coordinate is, as we shall discover in a moment, that the holdings
H 0 in the numéraire asset S 0 will be no longer of importance when we do the
t t
book-keeping in terms of the numéraire asset, i.e., in discounted terms.
One can make the following easy, but crucial observation: for every Rd -
valued, predictable process (Ht )Tt=1 = (Ht1 , . . . , Htd )Tt=1 there exists a unique
self financing Rd+1 -valued predictable process (H  t )Tt=1 = (H
 t0 , H
 t1 , . . . , H
 td )Tt=1
 j T j T  0
such that (Ht )t=1 = (Ht )t=1 for j = 1, . . . , d and H1 = 0. Indeed, one de-
termines the values of H  t+1
0
, for t = 1, . . . , T − 1, by inductively applying
(2.2). The strict positivity of (St0 )Tt=0
−1
implies that there is precisely one func-
 0
tion Ht+1 such that equality (2.2) holds true. Clearly such a function H  t+1
0
is