Bessel bridges decomposition with varying dimension: applications to finance (Q482808)

The authors consider a family of stochastic processes which contains the classical squared Bessel processes, namely, they give a natural extension of the family of a \(\delta\)-dimensional squared Bessel processes (\(\delta\geq 0\)) to the family of processes where \(\delta\) is replaced by a function \(\delta_u\) of the time variable. More precisely, they consider the so-called generalized squared Bessel process (GBESQ) \(X_u\) as the unique solution of the SDE \[ dX_u=(\delta_u+2\beta_uX_u)du+2\sqrt{X_u}dW_u,\quad X_0=x\geq 0. \] Several classical results are established for this process, including existence and uniqueness of the solution, scaling and additive properties of the solution. A Lévy-Itō representation of this process is established as well. The paper concludes with some applications in financial mathematics, namely: examples of GBESQ models in finance; simulation of stochastic volatility where the volatility process is a GBESQ process; evaluation of a zero coupon bond with interest rate as a GBESQ process; simulation of default times in credit risk models using a stochastic default intensity as a GBESQ process.