scientific article; zbMATH DE number 1292789

Martingales with discrete parameter (60G42) Stochastic analysis (60H99) Research exposition (monographs, survey articles) pertaining to game theory, economics, and finance (91-02) Stochastic models in economics (91B70)

Review text

The book presents in a rather self-contained form the methods and results of contemporary theory of discrete probabilistic models of financial markets. It is based on the contents of the course of lectures delivered by the author at the Moscow State University and preserves the lively style and the structure of the course of lectures. The first two lectures are the preliminary ones. One of them is dedicated to the exposition of basic concepts and objects of a financial market while the other one deals with elements of stochastic analysis. Here the author introduces mathematical notions necessary to describe the problems of financial markets. A reader finds here the definition of a stochastic base, martingales, local martingales and stochastic integrals as well as some fundamental facts of stochastic analysis such as a transformation of local martingales under locally absolutely continuous changes of measures (Girsanov's theorem). Stochastic equations and stochastic exponents as well as Ito's formula and optimal stopping of a stochastic sequence are briefly discussed here. A stochastic model of a financial market is discussed in the third lecture as well as the martingale characterization of the key properties of a market such as arbitrage and completeness. Next lecture deals with pricing of European options in complete markets. Here the reader can find the derivation of general formulas for computing prices and hedges strategies. These formulas are applied next to a binomial market model which is proved to be non-arbitrage and complete. Finally the classical CRR (Cox-Rose-Rubinstein) formula is derived. Pricing and hedging American options in complete markets is the topic to deal with in the fifth lecture. Here pricing of American options is treated as an optimal stopping problem and the fair price of an American option is determined as the value of the optimal stopping problem. This lecturer is finished with the exposition of the methodology of pricing American options. The concept of nonself-financing strategies whose values are formed with consumption or refinancing taken into account is discussed in lecture 6. To this end a stochastic sequence \(G_n\) determined by a consumption or investment appears in the ``balance equations for the portfolio value. Pricing European and American options with the use of G-financing strategies is covered and the pricing problem in the latter case is reduced to an optimal stopping problem with a payment. Incomplete market pricing options and problems of minimizing risks are discussed in lecture 7. Formulas for computing the ask and bid prices for convex contingent claims are derived here. Financial computations taking into account the risks of hedging contingent claims could be seen at the end of the chapter. Lectures 8 and 9 are devoted to the problem of optimal investments. The notions of forwards, futures are introduced here as well as the structure of their prices on complete markets. Finally the optimal investment portfolio is discussed. At the end of the lecture bonds are defined and the Ho-Lee model of their evolution is described. The study of the risk in choosing of the investment portfolio is continued in lecture 9. The utility functions are introduced here to study the yield of an investment and its optimization. As an example the optimal investment in the binomial market model is studied. The last lecture deals with continuous models of financial markets. It is shown that any discrete model can be treated as a model on a continuous time interval where prices change is a random step-process. Next the limiting procedure (as the discreteness step goes to zero) for the binomial model is proved to yield continuous Black-Scholes and Merton models. As the result the Black-Scholes formula is deduced by the limiting procedure from the CRR formula. Multinomial markets are considered in an Appendix which could be considered as an additional lecture. The book is carefully written and contain a short but clear introduction to the theory of stochastic modelling of financial markets. It could be highly recommended as an intoductory course to the topic for graduate students and specialists interested in financial mathematic problems.

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