lto lntcra-

Henrik Madsen
January 2006
Contents
1 Stochastic processes 2
2 Ito Integrals 9
21 Thc lto intcra 20
211 Somc jrojcrtic- ot thc lto intcra 2
212 Lxtcn-ion- ot thc lto intcra 3!
213 `uti-dimcn-iona lto intcra 3!
21! lto intcra dcncd y convcrcncc in
jroaiity 3o
21` A comjari-on ot lto and Stratonovich
intcra- 3
21o Thc lto jrocc-- and lto tormua !1
1
Chapter 1
Stochastic processes
Denition 1.1 A stochastic process is a parametrized
collection of random variables
{X
t
}
tT
dened on a probability space (, F, P) and assuming
values in R
n
.
Thc jaramctcr -jacc T i- u-uay thc hat-inc |0, ), indi-
catin thc timc Ior cach t T xcd wc havc a random
variac
X
t
().
On thc othcr hand, xin wc can con-idcr thc tunction
t X
t
(). t T
which i- cacd thc path ot X
t

So rouhy -jcakin a -tocha-tic jrocc-- i- a -y-tcm which

dcvcoj in timc in accordancc with jroaii-tic aw-
2
Example 1.1 Figure 1.1 illustrates one of the simplest
stochastic processes. Here X
n
is a random variable de-
noting the position at time n of a moving particle (n
0, 1, 2, . . .). Initially the particle is at the origin, X
0
0.
At n 1, there is a jump of one step, upwards to position
1 with probability
1
2
, and downwards to position -1 with
probability
1
2
. At n 2 there is a further jump, again
of one step upwards or downwards with equal probabil-
ity, the jumps at times n 1, 2 being independent. In
general,
X
n
X
n1
+ Z
n
(11)
where Z
n
, the jump at the nth step, is such that the ran-
dom variables {Z
1
, Z
2
, . . .} are mutually Bernoulli ran-
dom variables with thedistribution
Prob(Z
n
1) Prob(Z
n
1)
1
2
(n 1, 2, . . .).
(12)
3
Equation 1.1 taken with the initial condition X
0
0, is
equivalent to
X
n
Z
1
+ + Z
n
. (13)
A stochastic process on the form 1.3 is called a random walk.
O
O
O
O
O
O
O
O
O
O
O
O
O
time
P
o
s
i
t
i
o
n
0 2 4 6 8 10 12
-
2
0
2
4
Two independent realizations of a simple random walk
X
X
X
X
X
X
X
X
X
X
X
X
X
Figure 1.1:
4
An imjortant cncraization ot thc random wak i- whcn thc
,umj- may hajjcn at any timc t and whcn thc -izc ot thc
,umj- toow thc norma di-triution Thi- jrocc-- actuay
ajjcar- y a -iht modication ot thc jrocc-- aovc
Example 1.2 Suppose independent steps of length

t
are taken at time intervals of length t, with
Z
i

_
+1 for a positive step
1 for a negative step
where again Z
i
are independent Bernoulli random vari-
ables.
Now we dene
Y
t

t(Z
1
+ + Z
[t/t]
) (1!)
where |.| denotes the integer part. Then
E|Y
t
| 0, V |Y
t
| t|t/t| t
as t 0, and furthermore the central limit theorem
implies that Y
t
W
t
, where W
t
is gaussian. Actually
W
t
is a \icncr jrocc-- (Gard, 1988).
5
Denition 1.2 A Wiener process beginning at 0, with
drift and variance is a process W
t
with following
properties:
1. P{W
0
0} 1.
2. For all non-overlapping time intervals |t
1
, t
2
|, |t
3
, t
4
|
the random variables W
t
2
W
t
1
and W
t
4
W
t
3
are
independent.
3. For any time interval |t
1
, t
2
| W
t
2
W
t
1
is gaussian
distributed with
E|W
t
2
W
t
1
| (t
2
t
1
), (1`)
V |W
t
2
W
t
1
|
2
(t
2
t
1
). (1o)
lt 0 ic, thc mcan i- 0 thcn thc jrocc-- i- cacd
Brownian motion, dcnotcd B
t
lt a-o
2
1 thc thc
jrocc-- i- cacd standard Brownian motion -incc thcn
W
t
2
W
t
1
N(0, 1)
6
\c now -tatc -omc imjortant jrojcrtic- ot Lrownian motion
1 E|B
t
| 0
2 V |B
t
| E|B
t
B
t
|
2
t
3 cov|B
t+s
, B
t
| cov|B
t
, B
t+s
| E|B
t
B
t+s
|
2
t
! Thc jath ot B
t
() (ic thc tunction t B
t
()) i-
continuou- tor amo-t a
Proof.
1 E|B
t
| E|B
t
B
0
+ B
0
| E|B
t
B
0
| + E|B
0
|
0 + 0 0.
2 V |B
t
| V |B
t
B
0
+ B
0
| V |B
t
B
0
| + V |B
0
|

2
t + 0
2
t
3 cov|B
t+s
, B
t
| cov|B
t+s
B
t
+ B
t
, B
t
| cov|B
t+s

B
t
, B
t
| + cov|B
t
, B
t
| cov|B
t+s
B
t
, B
t
B
0
+B
0
| +
V |B
t
| cov|B
t+s
B
t
, B
t
B
0
| +cov|B
t+s
B
t
, B
0
| +
V |B
t
| 0 + 0 +
2
t
! Ior a jroot ot thi- -cc |1!, Ok-cnda| Loo-cy -jcakin
it i- jrovcn that B
t
() can c cxtcndcd to a continuou-
jrocc-- Y
t
() whcrc P(Y
t
() B
t
()) 1, tor a t
Thc jrocc--c- Y
t
() and B
t
() miht dicr cvcn thouh
thc jroaiity ot cquaity i- 1, thi- cxjain- why wc -ay
that thc jath i- continuou- tor amo-t a
7
Denition 1.3 A stochastic process X
t
is called stationary
if {X
t
} has the same distribution as {X
t+h
} for any
h > 0.
`otc that thc Lrownian motion i- not -tationary -incc V |B
t
|
V |B
s
| it s t. ut the increment B
t+h
B
t
is stationary
Iurthcrmorc, wc havc that
Thc Lrownian motion B
t
i- continuou- (`orc corrccty
B
t
ha- a continuou- version, and wc a--umc that wc
con-idcr -uch a continuou- vcr-ion)
Thc Lrownian motion B
t
i- nowhcrc dicrcntiac
Proof.
Thc non-dicrcntiaiity ot thc jrocc--, c in mcan
-quarc -cn-c, can c -ccn trom
E
_
(B
t+h
B
t
)
2
h
_


2
h
h
2


2
h
. h 0.
lt not -tatc othcrwi-c wc a--umc in thc toowin that B
t
i-
a standard Brownian motion
8
Chapter 2
Ito Integrals
ln thc toowin wc tocu- on ndin a rca-onac mathc-
matica intcrjrctation ot thc noi-c tcrm in thc cquation
da(t)
dt
(r(t) +

noise

)a(t)
ln a morc cncra torm
dX
dt
b(t, X
t
) + (t, X
t
)

noise

(21)
whcrc b and arc -omc ivcn tunction-
lt i- rca-onac to ook tor -omc -tocha-tic jrocc-- W
t
to
rcjrc-cnt thc noi-c tcrm, -o that
dX
dt
b(t, X
t
) + (t, X
t
)W
t
. (22)
La-cd on many -ituation-, onc i- cd to a--umc that W
t
ha-,
at ca-t ajjroximatcy thc-c jrojcrtic-
1 t
1
t
2
W
t
1
and W
t
2
arc indcjcndcnt,
2 W
t
i- -tationary,
3 E|W
t
| 0 tor a t
9
lt turn- out that thcrc doc- not cxi-t any rca-onac
-tocha-tic jrocc-- -ati-tyin oth 1 and 2, -uch a W
t
cannot
havc continuou- jath
10
Lowcvcr, thc covariancc tunction ot thc Lrownian motion i-
(s, t) min(s, t)
Lcncc
(s, t)
s

_
1 s < t
0 s > t
Thi- imjic- that thc mixcd -ccond dcrivativc doc- not cxi-t
Lowcvcr, it wc cacuatcd tormay

2
(s, t)
st
(s t)
That i-, tormay thc covariancc tunction ot thc dcrivativc ot
thc \icncr jrocc-- (or Lrownian motion) i- thc covariancc
tunction ot whitc noi-c, and hcncc that thc dcrivativc ot B
t
i- white noise
Iormay, W
t
aovc corrc-jond- to thc dcrivativc ot thc B
t

Thi- i- thc ackround tor rcjrc-cntin W

t
a- a cncraizcd
-toca-tic jrocc-- cacd thc white noise process
11
A morc rca-onac con-truction i- otaincd y rcwritin
cquation 22
`ow ct 0 t
0
< t
1
< < t
m
t and con-idcr a di-crctc
vcr-ion ot 22
X
k+1
X
k
b(t
k
, X
k
)t
k
+ (t
k
, X
k
)W
k
t
k
(23)
whcrc
X
j
X
t
j
, W
k
W
t
k
, t
k
t
k+1
t
k
.
`ow rcjacc W
k
t
k
y V
k
V
k+1
V
k
whcrc {V
t
}
t0
i-
-omc -uitac -tocha-tic jrocc--
Thc a--umjtion- 1,2, and 3 on W
t
-uc-t that V
t
-houd
havc stationary independent increments with mean 0
Such a jrocc-- cxi-t- and it turn- out that thc ony -uch
jrocc-- with continuou- jath- i- thc Lrownian motion B
t

(`otc that cvcn thouh thc Lrownian motion i- not -tation-

ary thc incrcmcnt- arc)
Thu- wc jut V
t
B
t
and otain trom cquation 23
X
k
X
0
+
k1

j=0
b(t
k
, X
k
)t
k
+
k1

j=0
(t
k
, X
k
)B
j
. (2!)
12
lt it i- jo--ic to jrovc that thc imit ot thc riht hand -idc
ot cquation 2! cxi-t- whcn t
j
0, thcn y ajjyin thc
u-ua intcration notation wc -houd otain
X
k
X
0
+
_
t
0
b(s, X
s
)ds +

_
t
0
(s, X
s
)dB

s
. (2`)
Thcn cquation 22 rcay mcan- that X
t
X
t
() i- a -tocha--
tic jrocc-- -ati-tyin cquation 2`
`ow wc wi conccntratc on thc cxi-tcncc ot

_
t
0
f(s, )dB
s
()

whcrc B
t
() i- 1-dimcn-iona Lrownian motion -tartin at
thc oriin
13
`ow -ujjo-c that 0 a < b and f(t, ) i- ivcn \c want
to dcnc
_
b
a
f(t, )dB
t
().
\c want to intcratc thc tunction f(t, ) B
t
() in thc
intcrva |0, b| Lcnc a -tcj tunction
1
(t, ) y

1
(t, ) B
t
i1
() t |t
i1
, t
i
| 1 i n
ic
1
(t, ) i- a -tcj tunction a- a tunction ot t and
1
(t, )
takc- thc vauc ot f in thc ctt cndjoint ot thc intcrva
|t
i1
, t
i
|
Lcnc anothcr -tcj tunction
2
(t, ) y

2
(t, ) B
t
i
() t |t
i1
, t
i
| 1 i n
ic
2
(t, ) i- a -tcj tunction a- a tunction ot t and
2
(t, )
takc- thc vauc ot f in thc riht cndjoint ot thc intcrva
|t
i1
, t
i
|
14
Ior thc tunction
1
wc ct
E|
_
b
0

1
(t, )dB
t
()| E|

j0
B
j
B
j
|

j0
E|B
j
(B
j+1
B
j
)|

j0
(E|B
j
B
j+1
| E|B
j
B
j
|)

j0
(E|B
j
B
j+1
| E|B
j
B
j
|)

j0
(
2
t
j

2
t
j
) 0.
Lut u-in thc tunction
2

E|
_
b
0

2
(t, )dB
t
()| E|

j0
B
j+1
B
j
|

j0
E|B
j+1
(B
j+1
B
j
)|

j0
(E|B
j+1
B
j+1
| E|B
j+1
B
j
|)

j0
(E|B
j+1
B
j+1
| E|B
j+1
B
j
|

j0
(
2
t
j+1

2
t
j
)

j0
(t
j+1
t
j
)
2
b.
15
Irom thi- wc -cc that wc can no oncr choo-c an aritrary
joint t |t
j
, t
j+1
| Thc toowin two choicc- havc turncd
out to c thc mo-t u-ctu onc-
1 Choo-c t t
j
tor t |t
j
, t
j+1
| (ic thc ctt cndjoint)
Thi- dcnc- thc Ito integral
2 Choo-c t (t
j
+ t
j+1
)/2 tor t |t
j
, t
j+1
| (ic thc mid-
joint ot thc intcrva) Thi- dcnc- Stratonovich integral
Thc lto intcra i- thc onc mo-t widcy u-cd (thouh in -omc
ca-c- thc Stratonovich intcra i- morc convcnicnt)
16
Irom now onc wc wi conccntratc on thc lto intcra `ow
wc mu-t nd out thc -ct ot tunction- wcrc thc ajjroximation
jroccdurc wi work out -uccc--tuy lt turn- out that it
work- wc it f ha- thc jrojcrty that cach ot thc tunction-
f(t
j
, ) only depends on the behaviour of B
s
() up
to time t
j
Thi- cad- to toowin conccjt-
Denition 2.1 Let B
t
() be n-dimensional Brownian
motion. Then we dene F
t
F
(n)
t
to be the -algebra
generated by the random variables B
s
() s t. In other
words, F
t
is the smallest -algebra containing all sets of
the form
{ B
t
1
() F
1
, , B
t
k
() F
k
}
where k 1, 2, . . . , t
j
t and F
t
j
R
n
are Borel sets.
Onc ottcn think- ot F
t
a- thc hi-tory ot B
s
uj to timc t
lt a tunction h R
n
i- F
t
mca-urac it mcan- that thc
vauc ot h() can c dccidcd trom thc vauc- ot B
s
() tor
s t
Ior cxamjc h() B
t/2
() i- F
t
mca-urac, whic h()
B
2t
() i- not Iinay, notc that F
s
F
t
tor s < t, ic {F
t
}
i- increasing
17
Denition 2.2 Let {N
t
}
t0
be an increasing family of
-algebras of subsets of . A process g(t, ) |0, |
R
n
is called N
t
-adapted if for each t 0 the function
h R
n
h() g(t, )
is N
t
measurable.
Thc jrocc-- g(t, ) B
t/2
() i- F
t
-adajtcd, whic thc jro-
cc-- g(t, ) B
2t
() i- not F
t
-adajtcd
18
Thc toowin dcnition, dcnc- thc ca-- ot tunction- tor
which thc lto intcra wi c dcncd
Denition 2.3 Let V V(a, b) be the class of functions
f(t, ) |0, ) R
n
such that:
1. (t, ) f(t, ) is B F measurable, where B de-
notes the Borel -algebra on |0, | and F denotes a
-algebra on .
2. f(t, ) is F
t
-adapted.
3. E|
_
b
a
f(t, )
2
dt| < .
19
2.1 The Ito integral
Thc idca ot dcnin thc intcra
I|f|()
_
b
a
f(t, )dB
t
()
whcrc B
t
i- 1-dimcn-iona Lrownian motion i- a- toow-
I|| i- dcncd tor -imjc ca-- ot tunction-
Thcn it i- -hown that cach f V can c ajjroximatcd
y -uch -
Iinay thi- i- u-cd to dcnc
_
fdB a- thc imit ot
_
dB
a- f (imit in L
2
(P))
20
A u-ctu ca-- ot tunction- i- dcncd a- toow-
Denition 2.4 A function V is called elementary
if it has the form
(t, )

j
e
j
()
[t
j
,t
j+1
[
(t)
where denote the characteristic (indicator) function.
`otc that thc tunction (t, ) i- a -tcj tunction a- a tunction
ot t -incc e
j
() i- ony a tunction ot in cach intcrva `otc
a-o that -incc V cach ot thc tunction- e
j
() mu-t c
F
t
j
-mca-urac
Ior thc tunction-
1
and
2
dcncd ctorc, thc tunction
1
i- F
t
j
mca-urcac whcrca-
2
i- not -incc
2
i- thc vauc ot
thc Lrownian motion at thc cnd ot thc intcrva |t
j
, t
j+1
|
Ior ccmcntary tuntion- (t, ) thc intcra i- dcncd a-
toow-
_
b
a
(t, )dB
t
()

j0
e
j
()|B
t
j+1
B
t
j
|(). (2o)
`ow it rcmain- to jrovc that cach tunction f V can
c ajjroximatcd y ccmcntary tunction- Ior thi- -cc |1!,
Ok-cnda|
21
Ior thc ccmcntary tunction wc havc
Theorem 2.1 (The Ito isometry) Let (t, ) be a bounded
elementary function then
E
_
__
b
a
(t, )dB
t
_
2
_
E
__
b
a

2
(t, )dt
_
.
Proof A- ctorc wc jut B
j
B
t
j+1
B
t
j
and dcnotc
B
t
j+1
a- B
j+1
Thcn
E|e
j
e
i
B
j
B
i
|
_
0 if i j
E|e
2
j
|(t
j+1
t
j
) if i j
-incc thc variac- e
j
e
i
B
j
and (B
i
) arc indcjcndcnt y
dcnition it i j Thu-
E
_
__
b
a
dB
_
2
_
E
__
b
a
dB
_
b
a
dB
_
(2)
E
_
_
_
_

j
e
j
B
j
_
_
_

i
e
i
B
i
_
_
_

i
E|e
j
e
i
B
j
B
i
| (2S)

i
E|e
2
i
t
j
| E
__
b
a

2
dt
_
.
22
Denition 2.5 (The Ito integral) Let f V(S, T ).
Then the lto intcra of f from S to T is dened by
_
T
S
f(t, )dB
t
() im
n
_
T
S

n
(t, )dB
t
() (limit in ) L
2
(P)
(29)
where {
n
} is a sequence of elementary functions such
that
E|
_
T
S
(f(t, )
n
(t, ))
2
dt| 0 as n (210)
Such a -cqucncc -ati-tyin thc aovc imit cxi-t- Thc vauc
ot thc intcra doc- not dcjcndt on thc actua choicc ot a-
on a- (210 hod- Iurthcrmorc, thc toowin imjortant
rc-ut toow-
Theorem 2.2 (The Ito isometry)
E
_
__
b
a
f(t, )dB
t
_
2
_
E
__
b
a
f
2
(t, )dt
_
f V(a, b)
.
Thcrc cxi-t- a tunction ot thc tyjc which convcrc- to f
unitormy, and it toow- thcn that thcorcm 22 i- a-o truc
23
Thc lto intcra can c cacuatcd u-in thc dcnition di-
rccty, that i-
Iind a -cqucncc {
n
} ot ccmcntary tunction- that aj-
jroximatc- f, ct (210)
-c (29) to nd thc intcra ot thc imit in L
2
(P) ot thc
intcra invovin
24
Thc toowin cxamjc iu-tratc- thc jrincijc
Example 2.1 Assume B
0
0. Then
_
t
0
B
s
dB
s

1
2
B
2
t

1
2
t (211)
Proof
Put
n
(s, )

j
B
j
()
[t
j
,t
j+1
)
(t), where B
j
B
t
j
.
Then
E|
_
t
0
(
n
B
s
)
2
ds| E|

j
_
t
j+1
t
j
(B
j
B
s
)
2
ds|

j
_
t
j+1
t
j
(s t
j
)ds

j
1
2
(t
j+1
t
j
)
2
0 as t
j
0
According to (2.9) the integral can be found as
_
t
0
B
s
dB
s
im
t
j
0
_
t
0

n
dB
s
im
t
j
0

j
B
j
B
j
25
Since
(B
2
j
) B
2
j+1
B
2
j
(B
j+1
B
j
)
2
+ 2B
j
(B
j+1
B
j
) (212)
(B
j
)
2
+ 2B
j
B
j
we have that
B
2
t

j
(B
2
j
)

j
(B
j
)
2
+ 2

B
j
B
j
Therefore

j
B
j
B
j

1
2
B
2
t

1
2

j
(B
j
)
2
Since

j
(B
j
)
2
t in L
2
as t
j
0, the result fol-
lows.
Note the extra term
1
2
t compared to ordinary integra-
tion.
26
2.1.1 Some properties of the Ito integral
Theorem 2.3 (Properties of the Ito integral) Let f, g
V(0, T) and let 0 a < b. Then
(i)
_
b
a
fdB
t

_
u
a
fdB
t
+
_
b
u
fdB
t
tor a.a.,
(ii)
_
b
a
(cf + g)dB
t
c
_
b
a
fdB
t
+
_
b
a
gdB
t
c constant tor a.a.,
(iii) E
__
b
a
fdB
t
_
0,
(iv)
_
b
a
f
2
dB
t
is F
b
measurable.
Thi- i- ca-y to jrovc tor ccmcntary tunction-, -o y takin
imit- wc otain thc rc-ut tor a f, g V(0, T)
27
An imjortant jrojcrty i- that the Ito integral is a mar-
tingale \c -ha rcturn to that joint attcr thc toowin
dcnition
Denition 2.6 Let (, F, P) be a probability space. A
ltration on (, F) is a family {M
t
}
t0
of -algebras
M
t
F such that
0 s < t M
s
M
t
(i.e. {M
t
} is increasing). An n-dimensional stochastic
process {M}
t0
on (, F, P) is called a martingale with
respect to a ltration {M}
t0
if
1. M
t
is M
t
-measurable for all t,
2. E||M
t
|| < ,
3. E|M
s
|M
t
| M
t
for all s t.
28
Example 2.2 Brownian motion B
t
in R is a martingale
with respect to the -algebra F
t
generated by {B
s
. s t}.
Clearly B
t
is F
t
-measurable and E||B
t
|| < since
E||B
t
||
2
E||B
t
|
2
| E|B
2
t
| B
2
0
+
2
t <
where the rst inequality follows from Jensens inequal-
ity. Now,
E|B
t+s
|F
t
| E|B
t+s
B
t
+ B
t
|F
t
|
E|B
t+s
B
t
|F
t
| + E|B
t
|F
t
| 0 + B
t
B
t
since B
t+s
B
t
is independent of F
t
and E|B
t+s
B
t
| 0.
29
Theorem 2.4 (The Ito integral is a martingale) If
f L
2
, the stochastic integral
X(t)
_
t
0
f(s, )dB
s
() (213)
is a martingale with respect to the ltration {M
t
}
t0
.
Proof Iir-t, notc that E|X(t)| < toow- trom X(t)
L
2
Ior thc ccmcntary tunction- it i- rcadiy -ccn that
E|X(t + s) X(t)|F
t
| E|X(t + s) X(t)| 0
Thc rc-ut toow- thcn y oin to thc imit -uch that thc
-tcjtunction- f
30
Theorem 2.5 Let f V(0, T). Then there exists a
t-continuous version of
_
t
0
f(s, )dB
s
() 0 t T
i.e. there exist a t-continuous stochastic process J
t
on
(, F, P) such that
P|J
t

_
t
0
fdB| 1 0 t T.
Irom now on it wc c a--umc that
_
t
0
f(s, )dB
s
() mcan-
a t-continuou- vcr-ion ot thc intcra
31
Theorem 2.6 Let f(t, ) V(0, T) for all T. then
X
t
X
0
+
_
t
0
f(s, )dB
s
() (21!)
is a martingale with respect to F
t
.
32
Thc tact that an lto intcra i- a martinac i- onc ot thc
rca-on- why lto intcra- arc thc mo-t widcy u-cd Actuay
thc rcvcr-c i- a-o truc Any F
t
martinac (with rc-jcct to
P
0
. whcrc P
0
thc jroaiity aw ot B
t
-tartin at 0) can
c rcjrc-cntcd a- an lto intcra Thi- rc-ut i- cacd thc
martingale representation theorem and i- a- toow-
Theorem 2.7 (Martingale representation theorem)
Suppose that M
t
is an F
t
martingale and that M
t

L
2
(P
0
) for all t 0. Then there exists a unique stochas-
tic process g(s, ) such that g V|0, t| for all t 0 and
M
t
() E|M
0
| +
_
t
0
g(s, )dB
s
() t 0.
Remark. L
2
-tand- tor a mca-urac tunction- with an
intcrac -quarc
33
2.1.2 Extensions of the Ito integral
2.1.3 Multi-dimensional Ito integral
Thi- rcquirc- a rcaxation ot thc mca-uraiity condition in
thc dcnition 23 \c -imjy con-idcr a arcr (and incrca--
in) tamiy ot -acra- H
t
-uch that
1 B
t
i- a martinac with rc-jcct to H
t
, and
2 f
t
i- H
t
-adajtcd
34
Lct B (B
1
, B
2
, . . . , B
n
) c n-dimcn-iona Lrownian mo-
tion and ct |
i,j
(t, )| c an mn matrix whcrc cach
cntry
i,j
(t, ) -ati-c- 1 and 3 in dcnition 23 and i- F
(n)
-
adajtcd Thcn u-in matrix notation wc dcnc
_
t
0
(t, )dB(t, )
_
t
0
_
_

11
(t, )
1n
(t, )

m1
(t, )
mn
(t, )
_
_
_
_
dB
1
(t, )

dB
n
(t, )
_
_
to c m1 matrix (ic coumn vcctor) who-c ith comjo-
ncnt i- a -um ot 1-dimcn-iona lto intcra-
n

j=1
_
t
0

i,j
(s, )dB
j
(s, ).
35
2.1.4 Ito integral dened by convergence in probability
Thi- rcquirc- a wcakcnin ot thc condition (iii) ot Lcnition
?? to
iii P|
_
t
0
f(s, )
2
ds < tor a t 0| 1 (21`)
Lct thc modicd ca-- ot tunction- c dcnotcd y W Thc
con-truction i- -ihty modicd
I|| i- dcncd tor -imjc ca-- ot tunction-
Thcn it i- -hown that cach f W can c ajjroximatcd
y -uch -
Iinay thi- i- u-cd to dcnc
_
fdB a- thc imit ot
_
dB
a- f (imit in jroaiity)
Thu- wc may dcnc
_
T
S
f(t, )dB
t
() im
n
_
T
S

n
(t, )dB
t
() (imit in) L
2
(P)
(21o)
A- ctorc a t-continuou- vcr-ion ot thi- intcra cxi-t-
36
2.1.5 A comparison of Ito and Stratonovich integrals
lt ha- ccn arucd that thc matcmatica intcrjrctation ot
thc cquation
dX
dt
b(t, X
t
) + (t, X
t
)W
t
. (21)
i- that X
t
i- a -oution ot thc intcra cquation
X
k
X
0
+
_
t
0
b(s, X
s
)ds +

_
t
0
(s, X
s
)dB

s
. (21S)
A- indicatcd jrcviou-y, thc lto intcra i- ,u-t onc intcrjrc-
tation ot

_
t
0
f(s, )dB
s
()

37
Thc Stratonovich intcra i- anothcr intcrjrctation, cadin
(in cncra) to dicrcnt rc-ut-
ln a comjari-on with thc ordinary (dctcrmini-tic) -oution
thc Stratonovich ha- an advantac thi- i- indicatcd in thc
toowin
Ior cach ct X
(n)
t
() c thc -oution ot thc corrc-jondin
(dctcrmini-tic) dicrcntia cquation
dX
dt
b(t, X
t
) + (t, X
t
)
dB
(n)
t
dt
(219)
Thcn X
(n)
t
() convcrc- to -omc tunction X
t
(), and it
turn- out that thi- -oution coincidc- with thc -oution o-
taincd y the Stratonovich integral
X
k
X
0
+
_
t
0
b(s, X
s
)ds +
_
t
0
(s, X
s
) dB
s
. (220)
38
Thi- imjic- that X
t
i- thc -oution ot thc toowin modied
Ito equation
X
k
X
0
+
_
t
0
b(s, X
s
)ds+
1
2
_
0
t

(s, X
s
)(s, X
s
)ds+
_
t
0
(s, X
s
)dB
s
.
(221)
whcrc

dcnotc- thc dcrivativc ot (x, t) with rc-jcct to

x Thc cquation- -how- that thcrc i- an cxjicit conncction
ctwccn thc two modc-
`oticc that thc two intcra- coincidc it (x, t) doc- not
dcjcnd on x
39
Thc toowin cxamjc iu-tratc- that thc Stratonovich intc-
ra corrc-jond- to thc ordinary (dctcrmini-tic) intcration
Example 2.3 Consider the stochastic integral:
_
t
0
B(s)dB(s) (222)
Dene
I
0
im

B(t
i
)(B(t
i+1
) B(t
i
)) (223)
I
1
im

B(t
i+1
)(B(t
i+1
) B(t
i
)) (22!)
Then, as we have shown previously,
I
1
I
0
im

(B(t
i+1
) B(t
i
))
2
t. (22`)
Hence, the result of the integral depends on the evalua-
tion point of the integrand.
Let us now consider
I

im

((1 )B(t
i
) + B(t
i+1
))B(t
i
) (22o)
im

_
B(t
i
)B(t
i
) + (B(t
i
))
2

(22)
im

_
1
2
(B
2
(t
i+1
) B
2
(t
i
)) + (
1
2
)(B(t
i
))
2
_
(22S)

1
2
(B
2
(t) B
2
(0)) + (
1
2
)t (229)
Now it is clearly seen that for 1/2, which correponds
to the Stratonovich intcra, the same result as for the
ordinary (deterministic) case is obtained.
40
`LXT
2.1.6 The Ito process and Ito formula
Thc a-ic dcnition ot lto intcra- i- not vcry u-ctu whcn
wc try to cvauatc a ivcn intcra Thi- i- -imiar to thc
-ituation tor ordinary licmann intcra-, whcrc wc do not
u-c thc a-ic dcnition, ut rathcr thc tundamcnta thcorcm
ot cacuu- ju- thc chain ruc in thc cxjicit cacuation- lt
turn- out that i- jo--ic to c-tai-h an Ito integral version
of the chain rule, called Ito formula, and it i- vcry u-ctu
tor cvauation ot lto intcra-
41
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43