A remark on the heat equation with a point perturbation, the Feynman-Kac formula with local time and derivative pricing (Q2349735)

This note contains an interpretation of results by \textit{S. Fassari} and \textit{F. Rinaldi} [Rend. Mat. Appl., VII. Ser. 31, No. 1--2, 35--52 (2011; Zbl 1247.35177)]. The authors study the self-adjoint operator \[ \frac 12\sigma^2H_\lambda := \frac 12\sigma^2[-\frac{d^2}{dx^2}+\lambda\delta(x)] \] and give an interpretation of the fundamental solution in terms of stochastic processes and a Feynman-Kac formula. The latter can explicitly be written in terms of a measure which is absolutely continuous with respect to the standard Wiener measure and the Radon-Nikodým derivative is given by \(\exp[-\frac 12\lambda L_{(t,0)}(x+X)]\), where \(L\) denotes the local time of Brownian motion at zero. Some applications to mathematical finance (classical Black-Scholes options vs.\ knock-out options) are included and it is shown that the present model `interpolates' these two extremes (corresponding to \(\lambda=0\) and \(\lambda=\infty\), respectively).