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The fundamentals of
Stochastic Financial
Mathematics
Seminar 6
4May12 2
Seminar 6.
Brownian motion
and the assumptions of
the BlackScholes model
4May12 3
The Geometric Brownian Motion
In efficient markets, financial prices should
display a random walk pattern.
More precisely, prices are assumed to follow a
Markov process, which is a particular
stochastic process independent of its history —
the entire distribution of the future price relies
on the current price only.
The past is irrelevant.
4May12 4
The Geometric Brownian Motion
These processes are built from the
following components, described in order
of increasing complexity:
The Wiener process
The generalized Wiener process
The Ito process
4May12 5
The Geometric Brownian Motion
A particular example of Ito process is the geometric
Brownian motion (GBM), which is described for the
variable S as
The process is geometric because the trend and volatility
terms are proportional to the current value of S.
This is typically the case for stock prices, for which
rates of returns appear to be more stationary than
raw dollar returns,
It is also used for currencies
S S t S z µ o A = A + A
S A
4May12 6
The Geometric Brownian Motion
Because represents the capital
appreciation only, abstracting from dividend
payments, μ represents the expected total rate
of return on the asset minus the rate of income
payment, or dividend yield in the case of stocks.
S S A
4May12 7
Example 1: A Stock Price Process
Consider a stock that pays no dividends,
has an expected return of10%per annum,
and volatility of 20% per annum.
If the current price is $100, what is the
process for the change in the stock price
over the next week?
What if the current price is $10?
4May12 8
Example 1: Solution
(A Stock Price Process)
The process for the stock price is
where is a random draw from a standard normal
distribution.
If the interval is one week, or
the mean is
and
( )
S S t t µ o c A = A + A ×
1 52 0.01923 t A = =
c
( )
0.10 1 52 0.001923 t µ A = × =
0.20 1 52 0.027735 t o A = × =
4May12 9
Example 1: Solution
(A Stock Price Process)
The process is
With an initial stock price at $100, this gives
With an initial stock price at $10, this gives
The trend and volatility are scaled down by a factor of ten
0.1923 2.7735 S c A = +
0.01923 0.27735 S c A = + ×
( )
$100 0.001923 0.027735 S c A = + ×
4May12 10
This model is particularly important
because it is the underlying process for
the BlackScholes formula
The key feature of this distribution is the fact that the
volatility is proportional to S.
This ensures that the stock price will stay positive.
Indeed, as the stock price falls, its variance decreases,
which makes it unlikely to experience a large down move
that would push the price into negative values
4May12 11
As the limit of this model is a normal
distribution for dS/S = d ln(S),
S follows a lognormal distribution.
This process implies that, over an interval
the logarithm of the ending price is distributed as
where is a standardized normal variable.
T t t ÷ =
2
ln ln
2
T
S S
t
o
µ t o t c
 
= + ÷ + ×

\ .
c
4May12 12
Example: A Stock Price Process
(Continued)
Assume the price in one week is given by
S = $100exp(R), where R has annual
expected value of 10% and volatility of
20%.
Construct a 95% confidence interval for S
4May12 13
Example: A Stock Price Process (Continued)
The standard normal deviates that corresponds to a 95%
confidence interval are αmin = −1.96 and αmax = 1.96.
In other words, we have 2.5% in each tail.
The 95% confidence band for R is then
and
This gives Smin = $100exp(−0.0524) = $94.89,
and Smax = $100exp(0.0563) = $105.79.
min
1.96
0.001923 1.96 0.027735 0.0524
R t t µ o = A ÷ A =
= ÷ × = ÷
max
1.96
0.001923 1.96 0.027735 0.0563
R t t µ o = A + A =
= + × =
4May12 14
The choice
lognormal & normal assumption
Whether a lognormal distribution is much better than the
normal distribution depends on the horizon considered.
If the horizon is one day only, the choice of the
lognormal versus normal assumption does not really
matter.
It is highly unlikely that the stock price would drop below
zero in one day, given typical volatilities.
On the other hand, if the horizon is measured in years,
the two assumptions do lead to different results.
The lognormal distribution is more realistic, as it
prevents prices from turning negative.
4May12 15
In simulations:
this process is approximated by small steps with a normal
distribution with mean and variance given by
To simulate the future price path for S, we start from the
current price St and generate a sequence of independent
standard normal variables , for i = 1, 2, . . . , n.
( )
2
,
S
N t t
S
µ o
A
e A A
4May12 16
In simulations:
The next price is built as
The following price is taken as
and so on until we reach the target horizon, at which
point the price should have a
distribution close to the lognormal.
( )
1 1 t t t
S S S t t µ oc
+
= + A + A
( )
2 1 1 2 t t t
S S S t t µ oc
+ + +
= + A + A
2 t
S
+
1 t
S
+
t n T
S S
+
=
4May12 17
4May12 18
Simulating a Price Path
4May12 19
4May12 20
4May12 21
Shortcomings of the model
While very useful to model stock prices, this
model has shortcomings.
Price increments are assumed to have a normal
distribution.
In practice, we observe that price changes have
fatter tails than the normal distribution.
Returns may also experience changing
variances.
4May12 22
Shortcomings of the model
In addition, as the time interval shrinks,
the volatility shrinks as well.
This implies that large discontinuities cannot
occur over short intervals.
In reality, some assets experience discrete
jumps, such as commodities. The stochastic
process, therefore, may have to be changed to
accommodate these observations
t A
4May12 23
1. A fundamental assumption of the random
walk hypothesis of market returns is that
returns from one time period to the next are
statistically independent.
This assumption implies
a. Returns from one time period to the next can never be
equal.
b. Returns from one time period to the next are
uncorrelated.
c. Knowledge of the returns from one time period does not
help in predicting returns from the next time period.
d. Both b) and c) are true.
4May12 24
2. Consider a stock with daily
returns that follow a random walk.
The annualized volatility is 34%.
Estimate the weekly volatility of this stock
assuming that the year has 52 weeks.
a. 6.80%
b. 5.83%
c. 4.85%
d. 4.71%
4May12 25
3. Assume an asset price variance increases
linearly with time. Suppose the expected
asset price volatility for the next two months
is 15% (annualized), and for the one month
that follows, the expected volatility is 35%
(annualized).
What is the average expected volatility over the
next three months?
a. 22%
b. 24%
c. 25%
d. 35%
4May12 26
4. In the geometric Brown motion
process for a variable S,
I. S is normally distributed.
II. d ln(S ) is normally distributed.
III. dS/S is normally distributed.
IV. S is lognormally distributed.
a. I only
b. II, III, and IV
c. IV only
d. III and IV
4May12 27
5. Consider that a stock price S that follows a
geometric Brownian motion dS = aSdt + bSdz,
with b strictly positive
Which of the following statements is false?
a. If the drift a is positive, the price one year from
now will be above today’s price.
b. The instantaneous rate of return on the stock
follows a normal distribution.
c. The stock price S follows a lognormal distribution.
d. This model does not impose mean reversion
4May12 28
6. If follows a geometric Brownian motion
and follows a geometric Brownian motion
which of the following is true?
a. ln(S1 + S2) is normally distributed.
b. S1 × S2 is lognormally distributed.
c. S1 × S2 is normally distributed.
d. S1 + S2 is normally distributed
2
S
1
S
4May12 29
7. Which of the following statements best
characterizes the relationship between
the normal and lognormal distributions?
a. The lognormal distribution is the logarithm of the
normal distribution.
b. If the natural log of the random variable X is
lognormally distributed, then X is normally distributed.
c. If X is lognormally distributed, then the natural log of
x is normally distributed.
d. The two distributions have nothing to do with one
another
4May12 30
8. Consider a stock with an initial price of $100.
Its price one year from now is given by
S = 100 × exp(r ),
The rate of return r is normally distributed with
a mean of 0.1 and a standard deviation of 0.2.
With 95% confidence, after rounding, S will be
between
a. $67.57 and $147.99
b. $70.80 and $149.20
c. $74.68 and $163.56
d. $102.18 and $119.53
4May12 31
9. Which of the following
statements are true?
I. The sum of two random normal variables is also a
random normal variable.
II. The product of two random normal variables is also a
random normal variable.
III. The sum of two random lognormal variables is also a
random lognormal variable.
IV. The product of two random lognormal variables is
also a random lognormal variable.
a. I and II only
b. II and III only
c. III and IV only
d. I and IV only
4May12 32
10. For a lognormal variable X, we know that
ln(X) has a normal distribution
with a mean of zero and a standard deviation
of 0.5
What are the expected value and the
variance of X?
a. 1.025 and 0.187
b. 1.126 and 0.217
c. 1.133 and 0.365
d. 1.203 and 0.399
4May12 33
Question 1
What would it mean to assert that the
temperature at a certain place follows a
Markov process? Do you think that
temperatures do, in fact, follow a Markov
process?
4May12 34
Question 1. Solution
Imagine that you have to forecast the future
temperature from
a) the current temperature,
b) the history of the temperature in the last week, and
c) a knowledge of seasonal averages and seasonal trends.
If temperature followed a Markov process, the history of
the temperature in the last week would be irrelevant.
To answer the second part of the question you might
like to consider the following scenario for the first week
in May:
(i) Monday to Thursday are warm days; today,
Friday, is a very cold day.
(ii) Monday to Friday are all very cold days.
What is your forecast for the weekend? If you are more
pessimistic in the case of the second scenario,
temperatures do not follow a Markov process.
4May12 35
Question 2
Can a trading rule based on the past
history of a stock's price ever produce
returns that are consistently above
average? Discuss
4May12 36
Question 2. Solution
The first point to make is that any trading
strategy can, just because of good luck, produce
above average returns.
The key question is whether a trading strategy
consistently outperforms the market when
adjustments are made for risk.
It is certainly possible that a trading strategy
could do this.
However, when enough investors know about
the strategy and trade on the basis of the
strategy, the profit will disappear.
4May12 37
Question 2. Solution
As an illustration of this, consider a phenomenon
known as the small firm effect.
Portfolios of stocks in small firms appear to have
outperformed portfolios of stocks in large firms when
appropriate adjustments are made for risk.
Papers were published about this in the early 1980s and
mutual funds were set up to take advantage of the
phenomenon.
There is some evidence that this has resulted in the
phenomenon disappearing.
4May12 38
Question 3
A company's cash position (in millions of dollars)
follows a generalized Wiener process with
a drift rate of 0.5 per quarter
a variance rate of 4.0 per quarter.
How high does the company's initial cash
position have to be for the company to have a
less than 5% chance of a negative cash position
by the end of one year?
4May12 39
Question 3. Solution
Suppose that the company's initial cash position
is x.
The probability distribution of the cash position
at the end of one year is
where is a normal probability
distribution with mean and standard
deviation .
( )
( )
4 0.5, 4 4 2.0, 4 x x   + × × = +
( )
,  µ o
µ
o
4May12 40
Question 3. Solution
The probability of a negative cash position at the
end of one year is
where is the cumulative probability that
a standardized normal variable (with mean zero
and standard deviation 1.0) is less than x.
( )
N x
2.0
4
x
N
+
 
÷

\ .
4May12 41
Question 3. Solution
From normal distribution tables
when:
i.e., when x = 4.5796.
The initial cash position must therefore be $4.56 million.
2.0
1.6449
4
x +
÷ = ÷
2.0
0.05
4
x
N
+
 
÷ =

\ .
4May12 42
Question 4
Consider a variable S that follows the process
For the first three years, and ;
for the next three years, and .
If the initial value of the variable is 5, what is
the probability distribution of the value of the
variable at the end of year 6?
dS dt dz µ o = +
2 µ =
3 o =
3 µ = 4 o =
4May12 43
Question 4. Solution
The change in S during the first three years
has the probability distribution
The change during the next three years has
the probability distribution
( )
( )
2 3, 3 3 6, 5.20   × × =
( )
( )
3 3, 4 3 9, 6.93   × × =
4May12 44
Question 4. Solution
The change during the six years is the sum of:
a variable with probability distribution
and a variable with probability distribution
The probability distribution of the change is
therefore
Since the initial value of the variable is 5, the
probability distribution of the value of the
variable at the end of year six is
( )
6, 5.20 
( )
9, 6.93 
( )
20, 8.66 
( )
( )
2 2
6 9, 5.20 6.93 15, 8.66   + + =
4May12 45
Question 5
Stock A and stock В both follow geometric
Brownian motion. Changes in any short
interval of time are uncorrelated with each
other.
Does the value of a portfolio consisting of
one of stock A and one of stock В follow
geometric Brownian motion? Explain your
answer.
4May12 46
Question 5. Solution
4May12 47
Question 5. Solution
Seminar 6.
Brownian motion and the assumptions of the BlackScholes model
4May12
2
The Geometric Brownian Motion
In efficient markets, financial prices should display a random walk pattern. More precisely, prices are assumed to follow a Markov process, which is a particular stochastic process independent of its history — the entire distribution of the future price relies on the current price only. The past is irrelevant.
3
4May12
The Geometric Brownian Motion
These processes are built from the following components, described in order of increasing complexity:
The Wiener process The generalized Wiener process The Ito process
4May12
4
This is typically the case for stock prices. for which rates of returns appear to be more stationary than raw dollar returns. which is described for the variable S as S S t S z The process is geometric because the trend and volatility terms are proportional to the current value of S. S It is also used for currencies 4May12 5 .The Geometric Brownian Motion A particular example of Ito process is the geometric Brownian motion (GBM).
abstracting from dividend payments. 4May12 6 .The Geometric Brownian Motion Because S S represents the capital appreciation only. or dividend yield in the case of stocks. μ represents the expected total rate of return on the asset minus the rate of income payment.
Example 1: A Stock Price Process Consider a stock that pays no dividends. has an expected return of10%per annum. If the current price is $100. what is the process for the change in the stock price over the next week? What if the current price is $10? 7 4May12 . and volatility of 20% per annum.
If the interval is one week.027735 8 4May12 . or t 1 52 0.20 1 52 0.10 1 52 0.Example 1: Solution (A Stock Price Process) The process for the stock price is where is a random draw from a standard normal distribution.001923 t 0.01923 the mean is and S S t t t 0.
001923 0.27735 The trend and volatility are scaled down by a factor of ten 9 4May12 .027735 With an initial stock price at $100.01923 0.Example 1: Solution (A Stock Price Process) The process is S $100 0. this gives S 0.1923 2.7735 With an initial stock price at $10. this gives S 0.
its variance decreases. which makes it unlikely to experience a large down move that would push the price into negative values 4May12 10 . as the stock price falls.This model is particularly important because it is the underlying process for the BlackScholes formula The key feature of this distribution is the fact that the volatility is proportional to S. This ensures that the stock price will stay positive. Indeed.
S follows a lognormal distribution. 11 .As the limit of this model is a normal distribution for dS/S = d ln(S). over an interval T t the logarithm of the ending price is distributed as 2 ln ST ln S 2 where 4May12 is a standardized normal variable. This process implies that.
Construct a 95% confidence interval for S 4May12 12 .Example: A Stock Price Process (Continued) Assume the price in one week is given by S = $100exp(R). where R has annual expected value of 10% and volatility of 20%.
96.027735 0. and Smax = $100exp(0.96 0.89.96 t and 0.96 t 0.Example: A Stock Price Process (Continued) The standard normal deviates that corresponds to a 95% confidence interval are αmin = −1.0563 This gives Smin = $100exp(−0.0563) = $105.001923 1.0524 Rmax t 1.79. we have 2. The 95% confidence band for R is then Rmin t 1.96 and αmax = 1. 4May12 13 .001923 1.5% in each tail.0524) = $94.96 0. In other words.027735 0.
On the other hand. If the horizon is one day only. as it prevents prices from turning negative. given typical volatilities. the two assumptions do lead to different results. The lognormal distribution is more realistic.The choice lognormal & normal assumption Whether a lognormal distribution is much better than the normal distribution depends on the horizon considered. the choice of the lognormal versus normal assumption does not really matter. if the horizon is measured in years. 14 4May12 . It is highly unlikely that the stock price would drop below zero in one day.
2. for i = 1. 4May12 15 . . n. . t S To simulate the future price path for S. . we start from the current price St and generate a sequence of independent standard normal variables .In simulations: this process is approximated by small steps with a normal distribution with mean and variance given by S 2 N t . .
at which point the price S should have a t n ST distribution close to the lognormal. 4May12 16 .In simulations: The next price St 1 is built as St 1 St St t 1 t The following price St 2 is taken as St 2 St 1 St 1 t 2 t and so on until we reach the target horizon.
4May12 17 .
Simulating a Price Path 4May12 18 .
4May12 19 .
4May12 20 .
Price increments are assumed to have a normal distribution. In practice. this model has shortcomings. Returns may also experience changing variances. 21 4May12 . we observe that price changes have fatter tails than the normal distribution.Shortcomings of the model While very useful to model stock prices.
such as commodities. This implies that large discontinuities cannot occur over short intervals. some assets experience discrete jumps. the volatility shrinks as well. therefore. In reality. as the time interval t shrinks.Shortcomings of the model In addition. The stochastic process. may have to be changed to accommodate these observations 4May12 22 .
This assumption implies a. b. A fundamental assumption of the random walk hypothesis of market returns is that returns from one time period to the next are statistically independent. 23 4May12 .1. Knowledge of the returns from one time period does not help in predicting returns from the next time period. Returns from one time period to the next can never be equal. d. c. Returns from one time period to the next are uncorrelated. Both b) and c) are true.
85% d.71% 24 4May12 .80% b. 6. Consider a stock with daily returns that follow a random walk. 4. 5. The annualized volatility is 34%. 4. a.83% c.2. Estimate the weekly volatility of this stock assuming that the year has 52 weeks.
Assume an asset price variance increases linearly with time. 22% b. the expected volatility is 35% (annualized). 35% 25 4May12 . 25% d.3. Suppose the expected asset price volatility for the next two months is 15% (annualized). and for the one month that follows. 24% c. What is the average expected volatility over the next three months? a.
d ln(S ) is normally distributed. IV only d. III and IV 26 4May12 . IV. In the geometric Brown motion process for a variable S.4. dS/S is normally distributed. I. a. II. III. I only b. S is normally distributed. and IV c. II. III. S is lognormally distributed.
The instantaneous rate of return on the stock follows a normal distribution. Consider that a stock price S that follows a geometric Brownian motion dS = aSdt + bSdz. If the drift a is positive.5. c. The stock price S follows a lognormal distribution. This model does not impose mean reversion 4May12 27 . d. b. with b strictly positive Which of the following statements is false? a. the price one year from now will be above today’s price.
S1 + S2 is normally distributed which of the following is true? 4May12 28 . d. ln(S1 + S2) is normally distributed. b. c. S1 × S2 is lognormally distributed. S1 × S2 is normally distributed. If and S1 follows a geometric Brownian motion S 2 follows a geometric Brownian motion a.6.
c. d.7. b. then X is normally distributed. The lognormal distribution is the logarithm of the normal distribution. then the natural log of x is normally distributed. Which of the following statements best characterizes the relationship between the normal and lognormal distributions? a. If X is lognormally distributed. The two distributions have nothing to do with one another 29 4May12 . If the natural log of the random variable X is lognormally distributed.
99 b.56 d.57 and $147. With 95% confidence. $102.1 and a standard deviation of 0. $67. S will be between a. The rate of return r is normally distributed with a mean of 0. Consider a stock with an initial price of $100. Its price one year from now is given by S = 100 × exp(r ). $74.68 and $163.80 and $149.18 and $119.20 c. $70.8.2.53 30 4May12 . after rounding.
IV. The product of two random lognormal variables is also a random lognormal variable. II and III only c. Which of the following statements are true? I.9. I and IV only 31 4May12 . II. The product of two random normal variables is also a random normal variable. III and IV only d. III. I and II only b. a. The sum of two random lognormal variables is also a random lognormal variable. The sum of two random normal variables is also a random normal variable.
For a lognormal variable X.126 and 0.365 d. 1.217 c. we know that ln(X) has a normal distribution with a mean of zero and a standard deviation of 0.025 and 0.399 32 4May12 .5 What are the expected value and the variance of X? a. 1. 1. 1.203 and 0.187 b.133 and 0.10.
Question 1 What would it mean to assert that the temperature at a certain place follows a Markov process? Do you think that temperatures do. in fact. follow a Markov process? 4May12 33 .
temperatures do not follow a Markov process. b) the history of the temperature in the last week. 4May12 . (ii) Monday to Friday are all very cold days. 34 (i) Monday to Thursday are warm days. Friday. and c) a knowledge of seasonal averages and seasonal trends.Question 1. is a very cold day. To answer the second part of the question you might like to consider the following scenario for the first week in May: a) the current temperature. What is your forecast for the weekend? If you are more pessimistic in the case of the second scenario. today. Solution Imagine that you have to forecast the future temperature from If temperature followed a Markov process. the history of the temperature in the last week would be irrelevant.
Question 2 Can a trading rule based on the past history of a stock's price ever produce returns that are consistently above average? Discuss 4May12 35 .
the profit will disappear. just because of good luck. when enough investors know about the strategy and trade on the basis of the strategy. It is certainly possible that a trading strategy could do this. The key question is whether a trading strategy consistently outperforms the market when adjustments are made for risk. Solution The first point to make is that any trading strategy can. 36 4May12 . However. produce above average returns.Question 2.
Papers were published about this in the early 1980s and mutual funds were set up to take advantage of the phenomenon. consider a phenomenon known as the small firm effect. 37 4May12 . Portfolios of stocks in small firms appear to have outperformed portfolios of stocks in large firms when appropriate adjustments are made for risk.Question 2. Solution As an illustration of this. There is some evidence that this has resulted in the phenomenon disappearing.
How high does the company's initial cash position have to be for the company to have a less than 5% chance of a negative cash position by the end of one year? 4May12 38 .0 per quarter.Question 3 A company's cash position (in millions of dollars) follows a generalized Wiener process with a drift rate of 0.5 per quarter a variance rate of 4.
4 4 x 2.5. 4May12 39 .0. is a normal probability distribution with mean and standard deviation .Question 3. 4 where . The probability distribution of the cash position at the end of one year is x 4 0. Solution Suppose that the company's initial cash position is x.
Solution The probability of a negative cash position at the end of one year is where N x is the cumulative probability that a standardized normal variable (with mean zero and standard deviation 1.0) is less than x.Question 3. x 2.0 N 4 4May12 40 .
6449 4 i.Question 3.5796.0 N 0.e.56 million..0 1.05 4 when: x 2. when x = 4. 4May12 41 . The initial cash position must therefore be $4. Solution From normal distribution tables x 2.
Question 4 Consider a variable S that follows the process dS dt dz For the first three years. If the initial value of the variable is 5. 2 3 and and 4 3 . for the next three years. what is the probability distribution of the value of the variable at the end of year 6? 42 4May12 . .
6. 5.Question 4.20 The change during the next three years has the probability distribution 3 3.93 4May12 43 . Solution The change in S during the first three years has the probability distribution 2 3. 3 3 6. 4 3 9.
5. 8.93 The probability distribution of the change is therefore 2 2 6 9. the probability distribution of the value of the variable at the end of year six is 20. 5.Question 4.93 15.66 Since the initial value of the variable is 5.66 4May12 44 . 8. 6.20 and a variable with probability distribution 9.20 6. Solution The change during the six years is the sum of: a variable with probability distribution 6.
Does the value of a portfolio consisting of one of stock A and one of stock В follow geometric Brownian motion? Explain your answer. Changes in any short interval of time are uncorrelated with each other.Question 5 Stock A and stock В both follow geometric Brownian motion. 45 4May12 .
Question 5. Solution 4May12 46 .
Solution 4May12 47 .Question 5.
.
Solution The probability of a negative cash position at the end of one year is ¨ x 2.0 ¸ N © ¹ 4 º ª where N .Question 3.
x is the cumulative probability that a standardized normal variable (with mean zero and standard deviation 1. 15Dec15Dec11 40 .0) is less than x.
The initial cash position must therefore be $4.Question 3.e.5796.0 ! 1. 15Dec15Dec11 41 .. Solution From normal distribution tables ¨ x 2.05 4 º ª when: x 2.0 ¸ N © ¹ ! 0.56 million.6449 4 i. when x = 4.
If the initial value of the variable is 5. for the next three years. what is the probability distribution of the value of the variable at the end of year 6? 42 15Dec15Dec11 . Q ! 2 and W ! 3 . Q ! 3 and W ! 4 .Question 4 Consider a variable S that follows the process dS ! Q dt W dz For the first three years.
3 v 3 ! J . Solution The change in S during the first three years has the probability distribution J 2 v 3.Question 4.
20 .6. 5.
The change during the next three years has the probability distribution J 3 v 3. 4 v 3 ! J .
9.93 15Dec15Dec11 43 . 6.
.
Solution The change during the six years is the sum of: a variable with probability distribution J .Question 4.
5.6.20 and a variable with probability distribution J .
93 The probability distribution of the change is therefore 2 2 J 6 9. 6.20 6. 5.9.93 .
! J .
66 Since the initial value of the variable is 5.15. the probability distribution of the value of the variable at the end of year six is J . 8.
8.66 15Dec15Dec11 44 .20.
Changes in any short interval of time are uncorrelated with each other. Does the value of a portfolio consisting of one of stock A and one of stock follow geometric Brownian motion? Explain your answer. 45 15Dec15Dec11 .Question 5 Stock A and stock both follow geometric Brownian motion.
Solution 15Dec15Dec11 46 .Question 5.
Question 5. Solution 15Dec15Dec11 47 .
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