Bessel bridges decomposition with varying dimension: applications to finance

DOI10.1007/S10959-013-0496-XMaRDI QIDQ482808zbMATH OpenOpenAlexFDO

Authors Gabriel Faraud, Stéphane Goutte

Publication date 6 January 2015

Published in Journal of Theoretical Probability (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1205.0711

zbMATH Keywords

Bessel bridges decompositionfinancial applicationsLaplace transformLévy-Itō representationSDEsquared Bessel process

Mathematics Subject Classification ID

General theory of stochastic processes (60G07) Stochastic ordinary differential equations (aspects of stochastic analysis) (60H10) Computational methods for stochastic equations (aspects of stochastic analysis) (60H35) Stochastic models in economics (91B70) Credit risk (91G40) Financial applications of other theories (91G80)

Abstract: We consider a class of stochastic processes containing the classical and well-studied class of Squared Bessel processes. Our model, however, allows the dimension be a function of the time. We first give some classical results in a larger context where a time-varying drift term can be added. Then in the non-drifted case we extend many results already proven in the case of classical Bessel processes to our context. Our deepest result is a decomposition of the Bridge process associated to this generalized squared Bessel process, much similar to the much celebrated result of J. Pitman and M. Yor. On a more practical point of view, we give a methodology to compute the Laplace transform of additive functionals of our process and the associated bridge. This permits in particular to get directly access to the joint distribution of the value at t of the process and its integral. We finally give some financial applications to illustrate the panel of applications of our results.

Review text

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.

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Cites work

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• The spectral representation of Bessel processes with constant drift: applications in queueing and finance
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• On matching diffusions, Laplace transforms and partial differential equations
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• Pricing model for zero coupon bonds driven by Bessel-squared interest processes with a jump

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