Telegraph processes and option pricing (Q386156)

The book studies the movement of noninteracting mass-less particles in one dimension with alternating directions, finite velocity and finite intensity of change of directions per unit time. The stochastic processes that describe such a movement are called telegraph (or telegrapher's) stochastic processes.\newline The stochastic process which describes the movement of a mass-less particle at infinite speed on the real line and alternates at random two possible directions of motion infinitely many times per unit of time is called Brownian motion. It is of great interest to physicists and mathematicians and has been used to describe various real phenomena in statistical physics, optics, biology, hydrodynamics, financial markets and other fields of science and technology. It was discovered that the theoretical calculations based on this model agree well with the experimental data if the speed of the process is sufficiently high. If the speed is low, this agreement becomes worse. That is why many attempts were made to suggest alternative models in which the speed of motion and the intensity of changes of directions per unit time are finite.\newline The main objective of the book is to give the basic properties of the one-dimension telegraph processes and to present their applications to option pricing. The authors present both the well-known results and the most recent achievements in this field following a unified approach based on integral and differential equations.\newline The book consists of five chapters. In Chapter 1, the authors present some mathematical preliminaries, needed for further analysis. Markov processes, stochastic integrals, modified Bessel functions, generalised functions, and integral transforms are briefly considered here.\newline Chapter 2 introduces the telegraph process on the real line performed by a stochastic motion at finite speed, driven by a homogeneous Poisson process. The authors derive here the finite-velocity counterparts of the classical Kolmogorov equations for the joint transition densities of the process and its direction -- a hyperbolic system of two first-order partial differential equations with constant coefficients. A second-order telegraph equation for the transition densities of the process is also derived. Based on these equations, the authors obtain explicit formulae for the transition density of the process, its characteristic function, its limit as well as its Laplace transform.\newline In Chapter 3, some important functionals of telegraph processes are considered.\newline In Chaper 4, asymmetric telegraph processes with jumps are considered.\newline Chapter 5 is devoted to some contemporary applications of telegraph processes to financial modelling. Here, the classical Black-Scholes market model is modified by using the telegraph process instead of Brownian motion. To avoid arbitrage opportunities, the authors add a jump component to the telegraph process.\newline The authors suggest a new model to explain market's movement. They suppose that the log-returns are driven by a telegraph process -- they move with a pair of constant velocities alternating one to another at Poisson times with jumps occuring at these times. The jump-telegraph model captures bullish and bearish trends using velocity values and it describes crashes and spikes by means of jump values. At the same time, the model is analytically tractable.\newline The book is addressed to specialists in the area of diffusion processes with finite speed of propagation and in financial modelling. The book is also useful for students and postgraduates who make their first steps in this field.