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# Continuous-Time Finance

Sessions 1–4

Jyotirmoy Bhattacharya

ICRIER

IIM Kozhikode, January 2011

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 1 / 50

Sets and Functions

Set-theoretic terminology

Membership x ∈ A.

Subset A ⊂ B iff x ∈ A =⇒ x ∈ B. Also B ⊃ A.

Equality A = B iff A ⊂ B and B ⊂ A.

Null set ∅ is the set with no elements.

Real numbers R.

Rational numbers Q. Numbers of the form m/n where m and n are

integers and n = 0

Natural numbers N = {1, 2, 3, . . .}

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 2 / 50

Sets and Functions

Set-theoretic terminology (contd.)

Union If x ∈ A or x ∈ B then x ∈ A ∪ B.

Intersection If x ∈ A and x ∈ B then xinA ∩ B.

Complement x ∈ A

c

iff x ∈ A.

De Morgan’s Laws (A ∪ B)

c

= A

c

∩ B

c

. (A ∩ B)

c

= A

c

∪ B

c

. (Prove!)

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 3 / 50

Sets and Functions

Some subsets of R

Intervals

[a, b] = {x ∈ R|a ≤ x ≤ b}

(a, b) = {x ∈ R|a < x < b}

[a, b) = {x ∈ R|a ≤ x < b}

[a, ∞) = {x ∈ R|x ≥ a}

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 4 / 50

Sets and Functions

Useful properties of R

Archimedian property If x ∈ R, y ∈ R and x > 0, then there is a

positive integer n such that

nx > y.

Density of rationals If x ∈ R, y ∈ R, and x < y then there exists a

p ∈ Q such that x < p < y.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 5 / 50

Sets and Functions

Inﬁnite unions and intersections

Deﬁnition

Let A

1

, A

2

, . . . be an inﬁnite sequence of sets. Then,

∞

_

i =1

A

i

= {x| x ∈ A

n

for some n ∈ N}

∞

i =1

A

i

= {x| x ∈ A

n

for all n ∈ N}

Exercise

Compute

∞

i =1

(−1 −1/n, 1 + 1/n)

∞

i =1

[−1 + 1/n, 1 −1/n]

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 6 / 50

Sets and Functions

Cartesian Products and Functions

Cartesian Product

A ×B = {(a, b)| a ∈ A and b ∈ B}

Function

A function f from a set X to a set Y, written f : X →Y, is a subset

of X ×Y such that for any two elements (x

1

, y

1

) ∈ f and

(x

2

, y

2

) ∈ f , if x

1

= x

2

then y

1

= y

2

.

If (x, y) ∈ f , we write it commonly as y = f (x).

The set X is the domain of f and the set Y its codomain

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 7 / 50

Sets and Functions

Images and pre-images of sets

Let f : X →Y be a function.

Image

For any A ⊂ X, we deﬁne

f (A) = {y ∈ Y| there is some x ∈ A for which y = f (x)}

Pre-Image

For any B ⊂ Y, we deﬁne

f

−1

(B) = {x ∈ X| there is some y ∈ B for which y = f (x)}

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 8 / 50

Sets and Functions

Exercise

Let f (x) = x

2

. Find

1

f ({0, 1})

2

f

−1

({−4})

3

f ([0, 2])

4

f

−1

([−1, 4])

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 9 / 50

Sets and Functions

Exercise

Prove the following:

1

f

−1

(A

c

) = [f

−1

(A)]

c

2

f (A ∪ B) = f (A) ∪ f (B)

3

f (A ∩ B) ⊂ f (A) ∩ f (B). Why not equality?

4

f

−1

(A ∪ B) = f

−1

(A) ∪ f

−1

(B)

5

f

−1

(A ∩ B) = f

−1

(A) ∩ f

−1

(B)

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 10 / 50

Sets and Functions

Varieties of function

Let f : X →Y be a function.

Onto

If f (X) = Y then f is said to be onto.

One-to-one

If for every y ∈ Y, f

−1

({y}) consists of at most one element then f is

said to be 1-1.

Inverse

If f is 1-1 and onto, then we deﬁne a new function f

−1

: Y →X which

assigns to every y ∈ Y then unique element x ∈ X for which f (x) = y.

f

−1

is called the inverse function of f .

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 11 / 50

Sets and Functions

Exercise

Which of the following functions are 1-1, onto, or both:

1

f : R →R, where f (x) = x + 1

2

f : R →R, where f (x) = x

2

3

f : R →[0, ∞), where f (x) = x

2

4

f : [0, ∞) →R, where f (x) = x

2

5

f : N →N, where f (n) = 2n

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 12 / 50

Sets and Functions

Cardinality

Deﬁnition

If there exists a 1-1 mapping of A onto B, we say that A and B can be

put in 1-1 correspondence, or that A and B have the same cardinal

number, or, brieﬂy, that A and B are equivalent, and we write A ∼ B.

Exercise

Show that the set of natural numbers and the set of even natural

numbers have the same cardinal number.

Show that the set of natural number and the set of integers have

the same cardinal number.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 13 / 50

Sets and Functions

Countable and uncountable inﬁnite sets

Deﬁnition

For any positive integer n, let J

n

be the set whose elements are the

integers 1, 2, . . . , n; let J be the set consisting of all positive integers.

For any set A, we say:

A is ﬁnite if A ∼ J

n

for some n.

A is inﬁnite is A is not ﬁnite.

A is countable if A ∼ J.

A is uncountable if A is neither ﬁnite nor countable.

A is at most countable if A is ﬁnite or countable.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 14 / 50

Sets and Functions

Some countable and uncountable sets

N is countable.

Q is countable.

R is uncountable.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 15 / 50

Sets and Functions

Sequences and series

Sequence

A (real-valued) sequence is a function from N to R.

Inﬁnite series

For a sequence a

1

, a

2

, . . ., we write

∞

i =1

a

i

as a shorthand for

lim

n→∞

n

i =1

a

i

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 16 / 50

Sets and Functions

Limits of a sequence

Finite limit

We say

lim

n→∞

a

n

= L

if for any > 0 we can ﬁnd a N ∈ N such that for every n > N we have

|a

n

−L| <

Limit to inﬁnity

We say

lim

n→∞

a

n

= ∞

if for any M > 0 we can ﬁnd a N ∈ N such that for every n > N we have

a

n

> M

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 17 / 50

Sets and Functions

Existence of limits

In general a sequence may not have a limit. For eg. 0, 1, 0, 1, . . ..

Bounded monotonic sequence

If there is a number B such that a

n

≤ B for all n and if it is the case that

a

1

≤ a

2

≤ a

3

≤ · · · then the sequence a

n

has a limit.

Cauchy’s criteria

If for any > 0 there exists a N such that for all n > N and for all

m > N it is the case that

|a

n

−a

m

| <

then the sequence a

n

has a limit.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 18 / 50

Sets and Functions

Exercises

For all the exercises below a

n

and b

n

are two sequences such that

lim

n→∞

a

n

= a and lim

n→∞

b

n

= b.

1

If a

n

≤ b

n

for all n prove that a ≤ b.

2

If a

n

< b

n

for all n, can we prove that a < b?

3

If c

n

= a

n

+ b

n

prove that lim

n→∞

c

n

= a + b.

4

If c

n

= a

n

b

n

prove that lim

n→∞

c

n

= ab.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 19 / 50

Sets and Functions

Some useful limits

1

If p > 0, then lim

n→∞

1

n

p

= 0.

2

If p > 0, then lim

n→∞

n

√

p = 1.

3

lim

n→∞

n

√

n = 1.

4

If p > 0 and α is real, then lim

n→∞

n

α

(1+p)

n

= 0.

5

If |x| < 1, then lim

n→∞

x

n

= 0.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 20 / 50

Sets and Functions

Limits of functions

Deﬁnition

We say that

lim

x→a

f (x) = L

if for every > 0 we can ﬁnd a δ > 0 such that for every x such that

0 < |x −a| < δ

we have

|f (x) −L| <

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 21 / 50

Sets and Functions

Limit of a function (contd.)

Deﬁnition (equivalent to above)

We say that

lim

x→a

f (x) = L

if for every sequence a

n

such that a

n

= a for all n and lim

n→∞

a

n

= a

we have

lim

n→∞

f (a

n

) = L

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 22 / 50

Sets and Functions

Inﬁnite limits

Deﬁnition

We say that

lim

x→a

f (x) = ∞

if for every M > 0 we can ﬁnd a δ > 0 such that for every x for which

|x −a| < δ

it is the case that

f (x) > M.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 23 / 50

Sets and Functions

Limits at inﬁnity

Deﬁnition

We say that

lim

x→∞

f (x) = L

if for every > 0 we can ﬁnd a M > 0 such that for all x for which

x > M

it is the case that

|f (x) −L| <

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 24 / 50

Sets and Functions

Some useful limits

1

e

x

→+∞as x →+∞, e

x

→0 as x →−∞.

2

lim

x→+∞

x

n

e

−x

= 0, for every n.

3

lim

x→+∞

x

−α

logx = 0 for all α > 0.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 25 / 50

Sets and Functions

References

Smith, A. H. and Albrecht, W. A. Fundamental Concepts of

Analysis, PHI, Rs. 76

Malik, S. C. and Arora S. Mathematical Analysis, New Age

International, Rs. 276

Rudin, W. Principles of Mathematical Analysis, McGraw Hill,

Rs. 332.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 26 / 50

Sets and Functions

Probability

Sample space and events

The sample space Ω is the set of all possible outcomes. Variable

ω if often used to refer to elements of Ω.

Events correspond to subsets of Ω.

The set of events under consideration is required to be a

σ-algebra.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 27 / 50

Sets and Functions

σ-algebra

Deﬁnition

A collection F of subsets of Ω is a σ-algebra if

1

∅ ∈ F.

2

A ∈ F implies A

c

∈ F.

3

A

i

∈ F for i = 1, 2, 3, . . . implies

∞

i =1

A

i

∈ F.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 28 / 50

Sets and Functions

σ-algebra (contd.)

Examples

The set of all subsets of Ω, called the powerset of Ω, denoted 2

Ω

.

The set {Ω, ∅}.

For Ω = {HH, HT, TH, TT}, the set {Ω, ∅, {HH, HT}, {TH, TT}}.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 29 / 50

Sets and Functions

σ-algebra generated by a set of subsets

Deﬁnition

Let A be a set of subsets of Ω. Let S be the set of all σ-algebra which

are supersets of A. S is non-empty since it contains at least 2

Ω

.

We deﬁne σ(A), the σ-algebra generated by A to be

σ(A) =

F∈S

F

Exercise

Verify that σ(A) as deﬁned above is indeed a σ-algebra.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 30 / 50

Sets and Functions

Examples of generated σ-algebra

Examples

The Borel σ-algebra on R is the σ-algebra generated by open

intervals.

Let Ω be the set of all possible outcomes of an inﬁnite sequence of

coin tosses. We denote by Ω

0

the set of subsets of Ω that can be

deﬁned using the results of a ﬁnite number of tosses. The

σ-algebra generated by Ω

0

is denoted Ω

∞

.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 31 / 50

Sets and Functions

Exercise

Show that the Borel σ-algebra on R is also the σ-algebra

generated by closed intervals.

If ω denotes the outcome of an inﬁnite sequence of coin tosses,

deﬁne H

n

(ω) to be the number of heads in the ﬁrst n tosses of the

coin. Show that the set

S =

_

ω ∈ Ω

¸

¸

¸

¸

lim

n→∞

H

n

(ω)

n

=

1

2

_

is in Ω

∞

.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 32 / 50

Sets and Functions

Probability measure

Deﬁnition

Let Ω be a nonempty set and let F be a σ-algebra of subsets of Ω. A

probability measure P is a function that, to every set A ∈ F assigns a

number in [0, 1], called the probability of A and written P(A). We

require:

1

P(Ω) = 1.

2

Whenever A

1

, A

2

, . . . is a sequence of disjoint sets in F then

P

_

∞

_

n=1

A

n

_

=

∞

n=1

P(A

n

)

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 33 / 50

Sets and Functions

Exercise

Prove the following:

1

P(∅) = 0.

2

If A and B are disjoint events then P(A ∪ B) = P(A) +P(B).

3

P(A

c

) = 1 −P(A).

4

Let A

1

, A

2

, . . . is a sequence of events in F with the property that

A

1

⊂ A

2

⊂ · · · . Let A =

∞

i =1

A

i

. Then

P(A) = lim

n→∞

P(A

n

)

5

Let A

1

, A

2

, . . . is a sequence of events in F with the property that

A

1

⊃ A

2

⊃ · · · . Let A =

∞

i =1

A

i

. Then

P(A) = lim

n→∞

P(A

n

)

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 34 / 50

Sets and Functions

“Building-up” measures

Extension Theorem

A (countably additive) probability measure on a algebra of sets has a

unique extension to the generated σ-algebra.

Lebesgue measure on (0, 1]

The Lebesgue measure is the unique measure on the Borel σ-algebra

on (0, 1] obtained by assigning the length b −a to the interval (a, b]

and assuming that the length of a ﬁnite union of disjoint intervals is the

sum of the lengths of the component intervals.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 35 / 50

Sets and Functions

References

Basu, A. K. Measure Theory and Probability, Rs. 175.

Jacod, J. and Protter, P. Probability Essentials, Springer, Rs. 595.

Chung, K. L. Course in Probability Theory, Elsevier India, Rs. 295.

(advanced)

Billingsley, P. Probability and Measure, Wiley, Rs. 807 (advanced).

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 36 / 50

Sets and Functions

Set-theoretic terminology

Membership x ∈ A. Subset A ⊂ B iff x ∈ A =⇒ x ∈ B. Also B ⊃ A. Equality A = B iff A ⊂ B and B ⊂ A. Null set ∅ is the set with no elements. Real numbers R. Rational numbers Q. Numbers of the form m/n where m and n are integers and n = 0 Natural numbers N = {1, 2, 3, . . .}

Jyotirmoy Bhattacharya (ICRIER)

Continuous-Time Finance

IIMK Jan ’11

2 / 50

Sets and Functions

Set-theoretic terminology (contd.)

Union If x ∈ A or x ∈ B then x ∈ A ∪ B. Intersection If x ∈ A and x ∈ B then xinA ∩ B. Complement x ∈ Ac iff x ∈ A. De Morgan’s Laws (A ∪ B)c = Ac ∩ B c . (A ∩ B)c = Ac ∪ B c . (Prove!)

Jyotirmoy Bhattacharya (ICRIER)

Continuous-Time Finance

IIMK Jan ’11

3 / 50

∞) = {x ∈ R|x ≥ a} Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 4 / 50 .Sets and Functions Some subsets of R Intervals [a. b] = {x ∈ R|a ≤ x ≤ b} (a. b) = {x ∈ R|a < x < b} [a. b) = {x ∈ R|a ≤ x < b} [a.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 5 / 50 .Sets and Functions Useful properties of R Archimedian property If x ∈ R. Density of rationals If x ∈ R. y ∈ R. y ∈ R and x > 0. and x < y then there exists a p ∈ Q such that x < p < y . then there is a positive integer n such that nx > y.

Sets and Functions Inﬁnite unions and intersections Deﬁnition Let A1 . . A2 . Then. be an inﬁnite sequence of sets. ∞ Ai = {x| x ∈ An for some n ∈ N} i=1 ∞ Ai = {x| x ∈ An for all n ∈ N} i=1 Exercise Compute ∞ i=1 (−1 − 1/n. 1 + 1/n) ∞ i=1 [−1 + 1/n. . 1 − 1/n] Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 6 / 50 . .

is a subset of X × Y such that for any two elements (x1 . If (x. y) ∈ f . The set X is the domain of f and the set Y its codomain Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 7 / 50 .Sets and Functions Cartesian Products and Functions Cartesian Product A × B = {(a. if x1 = x2 then y1 = y2 . b)| a ∈ A and b ∈ B} Function A function f from a set X to a set Y . written f : X → Y . we write it commonly as y = f (x). y1 ) ∈ f and (x2 . y2 ) ∈ f .

Sets and Functions Images and pre-images of sets Let f : X → Y be a function. Image For any A ⊂ X . we deﬁne f −1 (B) = {x ∈ X | there is some y ∈ B for which y = f (x)} Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 8 / 50 . we deﬁne f (A) = {y ∈ Y | there is some x ∈ A for which y = f (x)} Pre-Image For any B ⊂ Y .

2]) f −1 ([−1. Find 1 2 3 4 f ({0.Sets and Functions Exercise Let f (x) = x 2 . 4]) Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 9 / 50 . 1}) f −1 ({−4}) f ([0.

Why not equality? f −1 (A ∪ B) = f −1 (A) ∪ f −1 (B) f −1 (A ∩ B) = f −1 (A) ∩ f −1 (B) Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 10 / 50 .Sets and Functions Exercise Prove the following: 1 2 3 4 5 f −1 (Ac ) = [f −1 (A)]c f (A ∪ B) = f (A) ∪ f (B) f (A ∩ B) ⊂ f (A) ∩ f (B).

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 11 / 50 . Inverse If f is 1-1 and onto. f −1 is called the inverse function of f . then we deﬁne a new function f −1 : Y → X which assigns to every y ∈ Y then unique element x ∈ X for which f (x) = y . One-to-one If for every y ∈ Y . f −1 ({y}) consists of at most one element then f is said to be 1-1.Sets and Functions Varieties of function Let f : X → Y be a function. Onto If f (X ) = Y then f is said to be onto.

or both: 1 2 3 4 5 f : R → R. where f (x) = x 2 f : [0. where f (x) = x 2 f : N → N. ∞) → R. where f (n) = 2n Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 12 / 50 .Sets and Functions Exercise Which of the following functions are 1-1. where f (x) = x + 1 f : R → R. ∞). where f (x) = x 2 f : R → [0. onto.

that A and B are equivalent. Exercise Show that the set of natural numbers and the set of even natural numbers have the same cardinal number. we say that A and B can be put in 1-1 correspondence. Show that the set of natural number and the set of integers have the same cardinal number. or. and we write A ∼ B. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 13 / 50 . or that A and B have the same cardinal number. brieﬂy.Sets and Functions Cardinality Deﬁnition If there exists a 1-1 mapping of A onto B.

A is at most countable if A is ﬁnite or countable. A is uncountable if A is neither ﬁnite nor countable. let Jn be the set whose elements are the integers 1. . Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 14 / 50 . we say: A is ﬁnite if A ∼ Jn for some n.Sets and Functions Countable and uncountable inﬁnite sets Deﬁnition For any positive integer n. . n. For any set A. 2. . A is inﬁnite is A is not ﬁnite. A is countable if A ∼ J. let J be the set consisting of all positive integers. .

Q is countable. R is uncountable. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 15 / 50 .Sets and Functions Some countable and uncountable sets N is countable.

a2 .Sets and Functions Sequences and series Sequence A (real-valued) sequence is a function from N to R. we write ∞ ai i=1 as a shorthand for n→∞ n lim ai i=1 Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 16 / 50 . .. . Inﬁnite series For a sequence a1 . .

Sets and Functions Limits of a sequence Finite limit We say n→∞ lim an = L if for any > 0 we can ﬁnd a N ∈ N such that for every n > N we have |an − L| < Limit to inﬁnity We say n→∞ lim an = ∞ if for any M > 0 we can ﬁnd a N ∈ N such that for every n > N we have an > M Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 17 / 50 .

. 0. Cauchy’s criteria If for any > 0 there exists a N such that for all n > N and for all m > N it is the case that |an − am | < then the sequence an has a limit. . For eg. 1. Bounded monotonic sequence If there is a number B such that an ≤ B for all n and if it is the case that a1 ≤ a2 ≤ a3 ≤ · · · then the sequence an has a limit.Sets and Functions Existence of limits In general a sequence may not have a limit. 1.. 0. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 18 / 50 . .

If cn = an bn prove that limn→∞ cn = ab. can we prove that a < b? If cn = an + bn prove that limn→∞ cn = a + b. If an < bn for all n. 1 2 3 4 If an ≤ bn for all n prove that a ≤ b. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 19 / 50 .Sets and Functions Exercises For all the exercises below an and bn are two sequences such that limn→∞ an = a and limn→∞ bn = b.

then limn→∞ If p > 0. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 20 / 50 . then limn→∞ If |x| < 1. then limn→∞ xn = 0. = 0. then limn→∞ √ limn→∞ n n = 1. 1 n √ n p = 0. p = 1. nα (1+p)n If p > 0 and α is real.Sets and Functions Some useful limits 1 2 3 4 5 If p > 0.

Sets and Functions Limits of functions Deﬁnition We say that x→a lim f (x) = L if for every > 0 we can ﬁnd a δ > 0 such that for every x such that 0 < |x − a| < δ we have |f (x) − L| < Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 21 / 50 .

) Deﬁnition (equivalent to above) We say that x→a lim f (x) = L if for every sequence an such that an = a for all n and limn→∞ an = a we have lim f (an ) = L n→∞ Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 22 / 50 .Sets and Functions Limit of a function (contd.

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 23 / 50 .Sets and Functions Inﬁnite limits Deﬁnition We say that x→a lim f (x) = ∞ if for every M > 0 we can ﬁnd a δ > 0 such that for every x for which |x − a| < δ it is the case that f (x) > M.

Sets and Functions Limits at inﬁnity Deﬁnition We say that x→∞ lim f (x) = L if for every > 0 we can ﬁnd a M > 0 such that for all x for which x >M it is the case that |f (x) − L| < Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 24 / 50 .

limx→+∞ x n e−x = 0. for every n. ex → 0 as x → −∞. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 25 / 50 .Sets and Functions Some useful limits 1 2 3 ex → +∞ as x → +∞. limx→+∞ x −α log x = 0 for all α > 0.

McGraw Hill. and Albrecht.Sets and Functions References Smith. Fundamental Concepts of Analysis. C. Mathematical Analysis. W. New Age International. Rs. A. 276 Rudin. 76 Malik. W. Rs. and Arora S. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 26 / 50 . PHI. Principles of Mathematical Analysis. A. S. 332. Rs. H.

Variable ω if often used to refer to elements of Ω. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 27 / 50 . Events correspond to subsets of Ω.Sets and Functions Probability Sample space and events The sample space Ω is the set of all possible outcomes. The set of events under consideration is required to be a σ-algebra.

. Ai ∈ F for i = 1.Sets and Functions σ-algebra Deﬁnition A collection F of subsets of Ω is a σ-algebra if 1 2 3 ∅ ∈ F. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 28 / 50 . 2. 3. . A ∈ F implies Ac ∈ F. . implies ∞ i=1 Ai ∈ F.

denoted 2Ω . TH. HT . TT }}. The set {Ω.Sets and Functions σ-algebra (contd. ∅}. {TH.) Examples The set of all subsets of Ω. HT }. For Ω = {HH. ∅. TT }. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 29 / 50 . the set {Ω. called the powerset of Ω. {HH.

Sets and Functions σ-algebra generated by a set of subsets Deﬁnition Let A be a set of subsets of Ω. We deﬁne σ(A). Let S be the set of all σ-algebra which are supersets of A. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 30 / 50 . S is non-empty since it contains at least 2Ω . the σ-algebra generated by A to be σ(A) = F ∈S F Exercise Verify that σ(A) as deﬁned above is indeed a σ-algebra.

The σ-algebra generated by Ω0 is denoted Ω∞ . Let Ω be the set of all possible outcomes of an inﬁnite sequence of coin tosses. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 31 / 50 . We denote by Ω0 the set of subsets of Ω that can be deﬁned using the results of a ﬁnite number of tosses.Sets and Functions Examples of generated σ-algebra Examples The Borel σ-algebra on R is the σ-algebra generated by open intervals.

Show that the set S= is in Ω∞ . If ω denotes the outcome of an inﬁnite sequence of coin tosses. deﬁne Hn (ω) to be the number of heads in the ﬁrst n tosses of the coin.Sets and Functions Exercise Show that the Borel σ-algebra on R is also the σ-algebra generated by closed intervals. ω ∈ Ω lim Hn (ω) 1 = n→∞ n 2 Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 32 / 50 .

is a sequence of disjoint sets in F then ∞ ∞ P n=1 An = n=1 P(An ) Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 33 / 50 . called the probability of A and written P(A). to every set A ∈ F assigns a number in [0. 1]. Whenever A1 .Sets and Functions Probability measure Deﬁnition Let Ω be a nonempty set and let F be a σ-algebra of subsets of Ω. A2 . . . A probability measure P is a function that. We require: 1 2 P(Ω) = 1. .

P(Ac ) = 1 − P(A). is a sequence of events in F with the property that A1 ⊂ A2 ⊂ · · · . If A and B are disjoint events then P(A ∪ B) = P(A) + P(B). . A2 . . Then i=1 P(A) = lim P(An ) n→∞ 5 Let A1 . Then i=1 P(A) = lim P(An ) n→∞ Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 34 / 50 . . Let A = ∞ Ai . . A2 . Let A = ∞ Ai . . .Sets and Functions Exercise Prove the following: 1 2 3 4 P(∅) = 0. is a sequence of events in F with the property that A1 ⊃ A2 ⊃ · · · . Let A1 .

Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 35 / 50 . Lebesgue measure on (0. 1] obtained by assigning the length b − a to the interval (a. b] and assuming that the length of a ﬁnite union of disjoint intervals is the sum of the lengths of the component intervals. 1] The Lebesgue measure is the unique measure on the Borel σ-algebra on (0.Sets and Functions “Building-up” measures Extension Theorem A (countably additive) probability measure on a algebra of sets has a unique extension to the generated σ-algebra.

Rs. Rs. Jacod. Probability Essentials. Measure Theory and Probability. 595. Springer. Wiley. 295.Sets and Functions References Basu. K. L. and Protter. 807 (advanced). K. Chung. P. 175. Probability and Measure. Rs. Course in Probability Theory. Jyotirmoy Bhattacharya (ICRIER) Continuous-Time Finance IIMK Jan ’11 36 / 50 . A. Elsevier India. J. P. Rs. (advanced) Billingsley.