SDEs - an Overview

Hausenblas Erika

Montanuniversity Leoben, Austria

October 12, 2023

1 / 75
Outline

Introduction and Motivation

The Brownian Motion and Stochastic integration
The Itô formula
Numerics
Applications
Lévy processes évy processes

Outline 2 / 75
Stochastic differential equations

The Problem
Let F : [0, T ] × Rd → Rd a Lipschitz continuous function. We now consider a
differential equation given by

(⋆) Ẋ (t) = F (t, X (t)) , t ≥ 0,

with initial condition X (0) = x0 .

What we are looking for: A function

X : [0, ∞) −→ Rd

such that (⋆) is satisfied.

Motivation 3 / 75
A simple example

The Problem
Let F : [0, T ] × Rd → Rd a Lipschitz continuous function.
Let A := (Ω, F, P) be a probability space on which some noise is defined.
We now consider a differential equation given by

(⋆) Ẋ (t) = F (t, X (t)) + ”noise” , t ≥ 0,

with initial condition X (0) = x0 . Here, noise is some random noise, usually not
predictable.

What we are looking for: A random process

X : [0, ∞) × Ω −→ Rd

such that (⋆) is satisfied.

Motivation 4 / 75
Stochastic DEs ⇌ deterministic ODEs

What is represented by the stochastic term:

the unknown feature (finance mathematics, insurance) ;

random fluctuations;
lack of information;
high complexity;

Motivation 5 / 75
Stochastic DEs ⇌ deterministic ODEs

The dynamical behaviour changes, if one add a noise term:

the Gaussian noise smears out bifurcations,

Crauel (2000), Crauel and Flandoli (1993,1998);
’Stochastic Resonanz’
Schimansky-Geier, Gentz, . . .;
often in contrary to the determininistic PDEs often a unique invariant
measures exists
Crauel und Flandoli, Mattingly, Rozovskii, Shirikyan and Kuksin, . . .;

Motivation 6 / 75
Which Processes

What type of noise will use?

Stochastic Processes The Brownian Motion 7 / 75

The Brownian motion

Let (Ω, F, (Ft )t≥0 , P) be a probability space. Then β = {β(t), t ∈ R+ } is

a one dimensional Brownian motion (BM) on (Ω; F; P) if
β(0) = 0;
the increments of β are independent;
β is P-a.s. continuous;;
for 0 ≤ s ≤ t < ∞, the difference βt − βs is normal distributed with
mean 0 and variance t − s;

Stochastic Processes The Brownian Motion 8 / 75

The Brownian motion
A one dimensional Brownian motion A one dimensional Brownian motion (several trajectories)

one trajectory of the Brownian motion

1.5 different trajectories of the Brownian motion
1.5

1
1

0.5
0.5

0
0

-0.5
-0.5

-1
-1

-1.5
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 -1.5
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

Stochastic Processes The Brownian Motion 9 / 75

Two different view points

different tracectories of the Brownian motion density of the Brownian motion at different time points
1.5 0.8

1 0.7

0.5 0.6

0 0.5

-0.5 0.4

-1 0.3

-1.5 0.2

-2 0.1

-2.5 0
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 -5 -4 -3 -2 -1 0 1 2 3 4 5

Fix t ∈ [0, ∞). Now we consider

Fix ω ∈ Ω. Now we consider the
the random variable and its distri-
trajectory given by
bution
X (ω, ·) : [0, ∞) ∋ t 7→ X (t, ω).
X (·, t) : Ω ∋ ω 7→ X (t, ω).

Stochastic Processes The Brownian Motion 10 / 75

Some properties of a Brownian motion

the BM is nowhere differentiable

the BM is P–a.s. Hölder continuous with exponent 12 ;
the quadratic variation of a BM is P–a.s. finite and
Nπ
X
lim |β(ti+1 ) − β(ti )|2 −→ t,
π→0
i=1

where π = {0 = t0 < · · · < tNπ } is a partition of the time interval

[0, t].1
at time t = 0 the value β(s), resp. W (s), is unknown for s > 0.
(important for nonlinear problems – in general no a’priori estimate are
possible);
(see e.g. Rogers, Williams: Diffusion, Markov processes and Martingales, 1979)
1
If f is differentiable, we get as limit 0.
Stochastic Processes The Brownian Motion 11 / 75
A simple example

The Problem
Let A = (Ω, F, (Ft )t≥0 , P) be a filtered probability space and B a Brownian
motion defined on A.
Let F : [0, T ] × Rd → Rd a Lipschitz continuous function. We now consider a
differential equation given by

(⋆) dX (t) = F (X (t)) dt + σ(X (t)) dB(t)

with initial condition X (0) = x0 . Here, noise is some random noise, usually not
predictable.

What we are looking for: A random process

X : Ω × [0, ∞) −→ Rd

such that (⋆) is satisfied.

Stochastic Processes The Brownian Motion 12 / 75

A simple example

Histogramm <=1
16

14

12

A double well potential 10

2
F (x) = (x − 1)(x − 2)(x + 10/3) . 2

-2
-5 -4 -3 -2 -1 0 1 2 3

The noisy system

u̇(t) = ∇F (u(t)) + ”noise”, u(0) = u0 .

Stochastic Processes A simple system with noise 13 / 75

A simple example

some movies

Stochastic Processes A simple system with noise 14 / 75

A simple example - a heuristic invariant measure

Histogramm <=1
16 70 45

14 40
60

12 35

50
10 30

8 40
25

6 20
30

4 15
20

2 10

10
0 5

-2 0 0
-5 -4 -3 -2 -1 0 1 2 3 -8 -6 -4 -2 0 2 4 6 -6 -5 -4 -3 -2 -1 0 1 2 3 4

50
σ = 7.5 σ = 3.5
140 350

45
120 300
40

35 100 250

30
80 200

25

60 150
20

15
40 100

10

20 50
5

0 0 0
-5 -4 -3 -2 -1 0 1 2 3 -5 -4 -3 -2 -1 0 1 2 3 4 -5 -4 -3 -2 -1 0 1 2 3 4

σ = 1.75 σ = 1.5 σ = 0.5

Stochastic Processes A simple system with noise 15 / 75

The Itô Integral

How is the Riemann integral constructed

1 We call a function f : [0, ∞) → R a simple functions, if there is a finite
sequence of numbers πn := {0 = t1 < · · · < tn = T } and a sequence of real
numbers a0 , . . . , an−1 such that
Pn−1
f (t) = j=0 aj 1[tj ,tj+1 ) (t), t ∈ [0, ∞).
2 Definition of the Riemann integral for for simple functions
R∞ Pn−1
0
f (s) ds = j=0 aj (tj+1 − tj ),
3 Denseness of the set of simple functions in Cb ([0, T ]; R)
4 Extension of the Riemann integral on Cb ([0, T ]; R) by taking the limit
|πn |a → 0.
a
For a partition π := {0 = t1 < · · · < tn = T } we define
|π| := max{tk+1 − tk | k = 1, . . . , n}.

The Itô Integral The Riemann integral 16 / 75

The Itô Integral - some definitions

What is a filtered probability space A = (Ω, F, (Ft )t≥0 , P) ?

What is an adapted (or progressively measurable ) process
X = {X (t) : t ≥ 0}?
What is a martingale? A continuous-time martingale on a filtered probability
space is a stochastic process {Mt : t ≥ 0} such that
E [Mt | Fs ] = Ms , for all t ≥ s,
E [|Mt |] < ∞ for all t ≥ 0.

The Itô Integral Some definitions 17 / 75

The Itô stochastic integral
Let B be a Brownian motion over a given filtered probability space
(Ω, F, (Ft )t≥0 , P).

Definition
We call f : [0, ∞) × Ω → R a random step process, if there is a finite sequence
of numbers πn := {0 = t1 < · · · < tn < ∞} and square integrable random
variables η0 , . . . , ηn−1 such that ηj is Ftj –measurable and
Pn−1
(⋆) f (t) = j=0 ηj 1[tj ,tj+1 ) (t), t ∈ [0, ∞).

2
Let us denote the set of random step processes by Mstep ([0, ∞); R).

Definition
2
The stochastic integral of a random step process f ∈ Mstep ([0, ∞); R) of the form
(⋆) is defined by
Pn−1
I (f ) = k=0 ηj (B(tj+1 ) − B(tj )).

The Itô Integral Some definitions 18 / 75

Properties of the Itô stochastic integral
Proposition - Itô isometry
2
For any random step process f ∈ Mstep ([0, ∞); R) the stochastic integral I (f ) is a
square integrable random variable, i.e. I (f ) ∈ L2 (Ω), such that
R∞
E|I (f )|2 = E 0 |f (t)|2 dt.

Other important properties

2
We have for any random step processes f , g ∈ Mstep ([0, ∞); R)
R∞
EI (f )I (g ) = E 0 f (t) g (t) dt.

2
Linearity: the operator I : Mstep ([0, ∞); R) → L2 (Ω) is a linear map, i.e. for
2
and random step processes f , g ∈ Mstep ([0, ∞); R) and any α, β ∈ R we
have
I (αf + βg ) = αI (f ) + βI (g ).

The Itô Integral Some definitions 19 / 75

The Itô stochastic integral

Definition
We denote by M 2 ([0, ∞); R) the class of (progressively measurable) stochastic processes
f : [0, ∞) × Ω → R such that
E 0∞ |f (t)|2 dt < ∞,
R

2 ([0, ∞); R) of random step processes

and there exists a sequence f1 , f2 , . . . ∈ Mstep
(∗) limn→∞ E 0∞ |f (t) − fn (t)|2 dt = 0.
R

2 ([0, ∞); R) of random step processes, we say the

If (∗) holds for a sequence f1 , f2 , . . . ∈ Mstep
sequence f1 , f2 , . . . approximates f .

Definition
We call I (f ) ∈ L2 (Ω) the Itô stochastic integral
 (from 0 to ∞) of f ∈ M 2 if
limn→∞ E |I (f ) − I (fn )|2 = 0
2 ([0, ∞); R) of random step processes that approximates
for any sequence f1 , f2 , . . . ∈ Mstep
f ∈ M 2 , i.e. (∗) is satisfied. We will write
R∞
0 f (s) dB(s)
in place of I (f ).

The Itô Integral Some definitions 20 / 75

The Itô Integral

Let (Ω; F; (Ft )t≥0 , P) be a filtered probability space and M a

R–valued martingale over (Ω; F; (Ft )t≥0 , P).
Let
f : R+ × R → R
adapted L2 integrable simple functions with representation:

N
X
f (s) := 1(ti ,ti+1 ] (s)fi , fi ∈ Fti .
i=1

Then the stochastic integral is defined by

N
X

(∗) I (f ) := fi Mti+1 − Mti .
i=1

The Itô Integral The definition 21 / 75

The Itô Integral
Let
n
M2 ([0, ∞); R) := f : Ω × [0, ∞) → L(Rd , Rd )
Z o
f is progressively measurable and E |f (s)|2 ds < ∞
R+

Theorem
There exists a linear bounded operator
I : M2 ([0, ∞); R) → L2 (Ω, P; E R),
which is the unique extension of the operator (∗).

For all f ∈ M2 ([0, ∞); R) and t > 0 let

Z t
f (s) dM(s) := I (1(0,t] h) .
0

The Itô Integral The definition 22 / 75

The Itô-Isometry

Proposition
For any f ∈ M2 ([0, ∞); R) the stochastic integral I (f ) is a square integrable
random variable, i.e. I (f ) ∈ L2 (Ω), such that
Z ∞
E|I (f )|2 = E |f (t)|2 dt.
0

The Itô Integral The definition 23 / 75

The Itô stochastic integral

Definition
For any t > 0 we denote by M 2 ([0, t]; R) the space of all stochastic processes
f : [0, t] × Ω → R such that

1[0,t] f ∈ M2 ([0, ∞); R).

The Itô stochastic integral (from 0 to t) is defined by

Z t

f (s) dB(s) := It (f ) = I 1[0,t] f .
0

The Itô Integral The definition 24 / 75

Properties

Theorem
The following properties hold for and f , g ∈ M2 ([0, ∞); R) and any α, β ∈ R
1 linearity
Z t Z t Z t
(αf (s) + βg (s)) dB(s) = α f (s) dB(s) + β g (s) dB(s)
0 0 0

2 isometry
Z t 2 Z t
2
E f (s) dB(s) =E |f (s)| ds
0 0

3 martingale property (and adaptivity)

Z t  Z r
E f (s) dB(s) | Fr = f (s) dB(s)
0 0

Properties of the stochastic integral 25 / 75

Properties

Burkholder Davis Gundy inequality

Let f ∈ M 2 ([0, ∞); Rd ). Then
Z t p Z t  p2
2
E sup f (s) dB(s) ≤E |f (s)| ds
0≤s≤t 0 0

Properties of the stochastic integral 26 / 75

Stochastic Differential Equations

Stochastic Differential Equations 27 / 75

The geometric Brownian motion

a simple deterministic differential equation

d
X (t) = aX (t), X (0) = x0
dt
The solution:

a simple stochastic differential equation

dX (t) = νX (t) + σX (t)dB(t), X (0) = x0

The solution:
σ2
  
X (t) = exp ν− t + σB(t) , t ≥ 0.
2

Stochastic Differential Equations An example from finance 28 / 75

Some simulations

Geometric Brownian motion with sigma=0.2 Geometric Brownian motion with sigma=0.2
2.6 1.5

2.4

1.4
2.2

2
1.3

1.8

1.6 1.2

1.4

1.1
1.2

1
1

0.8

0.6 0.9
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

Geometric Brownian motion with sigma=0.2 Geometric Brownian motion with sigma=0.05
1.25 1.2

1.2

1.15
1.15

1.1
1.1

1.05

1.05
1

0.95
1

0.9

0.85 0.95
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

Stochastic Differential Equations An example from finance 29 / 75

Some simulations

10 4 Realizations of Geometric Brownian Motion with different variances Realizations of Geometric Brownian Motion with different variances
3.5 12000
1 1
2.5 2.5
0.25 0.25
3
10000

2.5
8000

2
$x$

$x$
6000

1.5

4000
1

2000
0.5

0 0
0 0.5 1 1.5 2 2.5 3 3.5 4 0 0.5 1 1.5 2 2.5 3 3.5 4
$t$ $t$

Realizations of Geometric Brownian Motion with different variances Realizations of Geometric Brownian Motion with different variances
4500 3500
1 1
2.5 2.5
4000 0.25 0.25
3000

3500

2500
3000

2000
2500
$x$

$x$

2000
1500

1500
1000

1000

500
500

0 0
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2
$t$ $t$

Stochastic Differential Equations An example from finance 30 / 75

The Itô Formula
Given
a

dX (t) = b(t) dt + σ(t) dB(t), X (0) = 0.

a
Karatzas and Shreve, Brownian motion and stochastic calculus. (1991), Revuz and Yor, Continuous martingales and
Brownian motion (1991).

Note
P limh→0 h1 (B(t + h) − B(t))2 = 1 = 1.

⇒ Itô Formula:
Z t
F (X (t)) = F (x0 ) + F ′ (X (s)) b(s) ds
0
Z t
1 t ′′
Z
′
+ F (X (s))σ(s) dB(s) + F (X (s))σ 2 (s) ds .
0 2
| 0 {z }
Itô correction term
Stochastic Differential Equations An example from finance 31 / 75
Application of the geometric Brownian motion

Stock price prediction

Let {X (t) : t ≥ 0} be the price of a share. Then one can model it, by taking the
ration between X (t) and X (t + h). If one assume that

X (t + h)
∼ Normal distributed with variance σ 2 h
X (t)

then one ends up by the geometric Brownian motion without drift term.

Stochastic Differential Equations An example from finance 32 / 75

Existence and Uniqueness of solution

Banach fixed-point theorem

Let X be a Banach socae and T : X → X a strict contraction, then there
exists a unique fix point x ∗ ∈ X such that Tx ∗ = x ∗ .

Given
A filtered probability space, a Brownian motion B, and the equation

dX (t) = F (X (t)) dt + σ(X (t))dB(t), X (0) = x0 .

where F and σ are Lipschitz continuous. Then, there exists a unique solution
X = {X (t) : t ≥ 0} such that we have P-a.s.
Z t Z σ
X (t) = x0 + F (X (s)) ds + (X (s)) dB(s).
0 0

Stochastic Differential Equations Existence and Uniqueness of solution 33 / 75