Market completion with derivative securities (Q503398)

Let \(X_0\in \mathbb{R}^2\), \(W\) be a Brownian motion with values in \(\mathbb{R}^2\) given on a complete, filtered probability space \((\Omega,{\mathcal F}_1, ({\mathcal F}_{t})_{t\in[0,1]},P)\). Let us suppose that there exists a unique solution \(X\) to the following stochastic differential equation in \(\mathbb{R}^2\): \[ X_{t}=X_0+\int_{0}^{t}b(u,X_{u})du+\int_{0}^{t}\sigma(u,X_{u})dW_{u},\quad t\in [0,1]. \] The author obtains sufficient conditions on the functions \(b(t,x), \sigma(t,x)\), \(r(t,x), f(t,x)\) and \(g(x)\) under which the solution \((S^{F},S^{B},Z)\) to the forward-backward stochastic differential equation \[ \begin{aligned} S^{F}_{t}=S_0^{F}+ \int_{0}^{t}\exp\left\{-\int_0^{u}r(s,X_{s})ds\right\}(\nabla_{x}f\sigma)(u,X_{u})dW_{u},\\ S_{t}^{B} = \exp\left\{-\int_0^{1}r(u,X_{u})du\right\}g(X_1)-\int_{t}^1\exp\left\{-\int_0^{u}r(s,X_{s})ds\right\}Z_{u}dW_{u}\end{aligned} \] is well defined. Moreover, every martingale \(M\) under \(P\) is a stochastic integral with respect to the two-dimensional \(P\)-martingale \(S=(S^{F},S^{B})\) and the market model with traded securities \(S\) is complete under \(P\). An example of a stochastic volatility model being completed with a European call (or put) option is presented.