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Unformatted text preview: Lecture 15 Girsanov Theorem and Risk Neutral Valuation Assume the basic setting in a BS market: a riskless asset B following (14.1), a risky asset S following (14.2) with the Brownian filtration {F t } , defined in a probability space ( , F ,P ). 15.1 Value processes, selffinancing strategies, arbitrage An adapted process h = { ( h t , h 1 t ) : 0 t T } is called a dynamic portfolio in which h t B t represents the balance of bank account B at time t and h 1 t is the number of shares of stock S at time t . In general, we should define predictability in continuoustime and require h to be a predictable process. However, it is not necessary here due to the continuous sample paths of Brownian motion W , i.e. if h is adapted to the Brownian filtration, then it is predictable. V = { V t } is called the value process of a portfolio h where V t = h t B t + h 1 t S t , t [0 ,T ] . (15.1) It is intuitive to call h a selffinancing strategy if dV t = h t dB t + h 1 t dS t (15.2) at every t . But a formal definition is required. Definition 15.1 Assume R T E  h t  dt + R T Eh 2 1 t dt < . h is called a selffinancing strategy if V t = V + Z t h u dB u + Z t h 1 u dS u (15.3) for < t...
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 Spring '08
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