Assessment of Contingent Liabilities for Risk Assets Evolutions Built on Brownian Motion ()
1. Introduction
In reality, all financial markets are incomplete and the evolution of risky assets is discrete. The question arises, what random process describes the evolution of risky assets in the financial markets? This problem is important both from the perspective of the risk asset price behavior and from the risk hedging behavior of the risk asset.
In this work, which is a continuation of the paper [1], we construct the random processes based on the discrete geometric Brownian motion which can describe the evolution of risky assets. A new method of the description of martingale measures for the introduced class of evolutions of risk assets is developed. It is proved that every martingale measure can be represented as an integral on some measure on the set of extreme points of the set of martingale measures. This crucial fact is a base for the estimation of contingent liabilities in the incomplete financial markets with the evolution of risk assets introduced in [1]. The problem of estimation of the range of non arbitrage prices was began in the papers [2], [3] for the Levy exponential processes and the diffusion processes with jumps describing evolution of risk assets. The upper estimate for the standard call option payoff function in this paper coincides with the price of underlying asset. This fact is unacceptable from the economic point of view. In the proposed paper, we generalize the class of evolutions of risk assets proposed in [1] and which contains a class of evolutions built on the discrete geometric Brownian motion. For this class of evolutions of risk assets the set of martingale measures is described and the representation for every martingale measure as integral over the set of extreme points is obtained. Having this representation the formulas for the lower and upper bounds of non arbitrage prices are found. It is showed that the upper bound for the payoff functions of standard call option of European type is less than the price of underlying asset. The statistical estimates of parameters entering entering in the introduced evolutions of risk assets are obtained. The statistic for which the fair price of super-hedge is minimal is indicated.
In terms of statistical estimates the simple formulas for the fair price of super-hedge are obtained. Every estimate can be realized in the reality. This depends on distribution function of the observed dates in the financial market.
Assessment of risk in various systems was begun in papers [4] [5] [6] [7]. Construction of non-arbitrage model of evolution of risk assets see in [8] [9] [10] [11] [12]. Optional decomposition Theorems see in [13] [14] [15] [16].
2. A Wide Class of Non-Arbitrage Evolutions of Risky Assets
In this section, we generalize the results of the paper [1]. On the probability space
, let us consider the nonnegative random values
, satisfying the conditions
(1)
where we introduced the denotation
. Let
be a direct product of the measurable spaces
, where
,
,
, and under the σ-algebra
we understand the minimal σ-algebra, generated by the sets
. On the measurable space
, under the filtration
, we understand the minimal σ-algebra generated by the sets
, where
for
. Further, we consider the probability space
, where
. Denote
the random value which is given on the probability space
and is distributed as
on the probability space
.
Described in Lemma 5 [1] the set of equivalent measures to the measure
and such that
, we denote by
.
On the measurable space
, we introduce into consideration the set of
measures M, where Q belongs to M, if
. On the introduced
measurable space
let us consider the evolution of the risk asset given by the law
(2)
where the random values
are
-measurable,
, satisfy the conditions
. The main aim is to describe the set of martingale measures for the evolution of risk asset given by the formula (2). This problem we solved in Theorem 8 [1] in the case as the random values
.
Definition 1. Let
be a measurable space. The decomposition
, of the space
we call exhaustive one if the following conditions are valid:
1)
,
,
;
2) the
-th decomposition is a sub-decomposition of the n-th one, that is, for every j,
for a certain
;
3) the minimal σ-algebra containing all
, coincides with
.
The next Remark 1 is important for the construction of the filtration having the exhaustive decomposition.
Remark 1. Suppose that the measurable spaces
and
have the exhaustive decompositions
, and
, respectively, then the measurable space
also have the exhaustive decomposition
,
. Really,
1)
,
;
2) the
-th decomposition is a sub-decomposition of the n-th one, that is, for every
for a certain
;
3) the minimal σ-algebra containing all
,
, coincides with
.
In the next Lemma we give the sufficient condition of the existence of exhaustive decomposition. This Lemma is very important for the proof of the next Theorems [1].
Lemma 1. Let
be a measurable space with a complete separable metric space
and Borel σ-algebra
on it. Then
has an exhaustive decomposition.
Proof. If
is a countable dense set in
, then we denote
(3)
the countable set of open balls as
runs all positive rational numbers, where
is a metric in
. Prove that
, where
is a minimal σ-algebra generated by the sets (3). For this purpose let us prove that for every open set
the representation
(4)
is true, where
is a subset of positive integers, and
is a subset of positive rational numbers. Let us denote
. Suppose that
, then
, where
is a closure of the set A. Let the point
belong to the ball
and let us consider the ball
. The point
belongs to this ball and for every
the inequality
(5)
is true. Therefore
. Let the rational number
satisfies the inequalities
(6)
then
, since for every
,
. So, for
we found
and the rational number
such that
. The last prove the needed statement. To complete the proof of Lemma 1 let us construct the exhaustive decomposition. Let us
renumber the sets
putting by
,
,
, and so on. We put that
consists of two sets
and
. If the set
is constructed, then the set
we construct from the various set of the kind
. By construction the minimal σ-algebra
. Taking into account the previous part of the proof we have
. Lemma 1 is proved. □
Below, we describe completely the regular set of measures, introduced in [1], in the case as
,
,
,
, and the random values
,
, are integrable ones relative to the measure
. For this purpose, we introduce the denotations:
,
,
is a contraction of the measure
on the σ-algebra
,
is a contraction of the measure
on the σ-algebra
,
,
. Denote
and introduce the measure
on the σ-algebra
. Let us introduce the measurable space
, where
, is a direct product of the spaces
,
,
is a direct product of the σ- algebras
,
. At last, let
be a direct product of the measures
,
, and let
,
, be a direct product of the measures
,
, which is a countable additive function on the σ-algebra
for every
, where
(7)
for
,
,
.
In the next Theorem 1, we assume that the random values
,
, are integrable ones.
Theorem 1. On the measurable space
with the filtration
on it, every measure Q of the regular set of measures M for the random value
,
,
,
, has the representation
(8)
where the random value
satisfies the conditions
(9)
(10)
(11)
Proof. To prove Theorem, it needs to prove that the countable additive measure
at every fixed
is a measurable map from the measurable space
into the measurable space
for every fixed
. For
,
,
is a measurable map from the measurable space
into the measurable space
. The family of sets of the kind
,
,
, where
, the set I is an arbitrary finite set, forms the algebra of the sets that we denote by
. From the countable additivity of
,
is a measurable map from the
measurable space
into the measurable space
. Let T be a class of the sets from the minimal σ-algebra
generated by
for every subset E of that
is a measurable map from the measurable space
into the measurable space
. Let us prove that T is a monotonic class. Suppose that
,
,
. Then,
. From this, it follows that
is a measurable map from the measurable space
into the measurable space
. But,
is a measurable map from
into
. From this equality, it follows that the set
belongs to the class T. Since
, we have
(12)
The equalities (12) mean that
belongs to T, since
is a measurable map of
into
. Suppose that
,
,
. Then, this case is reduced to the previous one by the note that the sequence
,
, is monotonically increasing. From this, it follows that
. Therefore,
. Thus, T is a monotone
class. But,
. Hence, T contains the minimal monotone class generated by the algebra
, that is,
, therefore,
. Thus,
is a measurable map of
into
for
. The fact that the random value
satisfies the conditions (9)-(11) means that Q, given by the formula (8), is a countable additive function of sets and
. Moreover,
. It is evident that
,
.
Due to Lemma 4, [1], this proves that the set M is a regular set of measure. Theorem 1 is proved. □
Remark 2. The representation (8) for the regular set of measures M means that M is a convex set of equivalent measures. Since the random value
runs all bounded random values, satisfying the conditions (9 - 11), it is easy to show that the set of measures
,
,
, is the set of extreme points for the set M.
Let us introduce the denotations (see also [1])
(13)
(14)
Note that the σ-algebra
is generated by sets of the kind
, where
,
,
,
. Denote
the contraction of the measure
onto the σ-algebra
. Further we use the denotations
and
which are the contractions the measure
onto the σ-algebras
and
, correspondingly. If the measure Q belongs to the set of martingale measures (8), then
, or
. From this, for the measure Q the representation
(15)
is true if the random value
satisfies the condition
(16)
Since for the set
the representation
, is true, where
, then for the contraction
of the measure Q onto the σ-algebra
the representation
(17)
is true, where we introduced the denotations
and
which are the contractions of the measure
onto the σ-algebras
and
, correspondingly,
(18)
In the set
let us introduce the transformation
(19)
By the definition we put that for
the transformation
is identical one. Introduce the denotations
(20)
(21)
(22)
(23)
Theorem 2. Let
be a complete separable metric space and
be a Borel σ-algebra on it. If the condition
(24)
is true for
-measurable nonnegative random value
, then the closure of the set of points
,
, in metrics
on the real line contains the set of points
(25)
Proof. Let us find the conditions for the measurable functions
under which
. Introduce the denotation
(26)
Let the set B belongs to
, then
(27)
If to take into account the relations
(28)
and introduce the denotations
(29)
(30)
we obtain
(31)
It is evident that the expression (31) equals zero for every
if and only if as
(32)
The last equality (32) is valid if the equality
(33)
is true.
Now if for
satisfying the condition
(34)
to put
(35)
then
(36)
is a probability measure on the σ-algebra
.
Taking into account the denotation (26) and the formula (35), we obtain that the measure
(37)
is a probability measure on the σ-algebra
, where
(38)
satisfy the condition
(39)
due to the condition
(40)
So, we described the contraction of the martingale measure Q on the σ-algebra
for which
. It has the representation (37) with the strictly positive random values
satisfying conditions (39), (40).
Since
is a separable metric space, then it has an exhaustive decomposition. This is true for
which is also separable metric space for every
. On the probability space
, for every integrable finite valued random value
the sequence
converges to
with probability one, as
since it is a regular martingale. It is evident that for those
for which
,
,
(41)
Denote
. It is evident that
. For every
, the formula (41) is well defined and is finite. Let
be the subset of the set
, where the limit of the left hand side of the formula (41) does not exists. Then,
. For every
, the right hand side of the formula (41) converges to
. For
, denote
those set
for which
for a certain
. Then, for every integrable finite valued
(42)
Choose the sequence
(43)
where
,
. Then the sequence
satisfy the condition (40). Let us consider the sequence
(44)
Then the contraction of the sequence of martingale measures
generated by sequence (44) on the σ-algebra
is given by the formula
(45)
Due to the invariance of the measure
relative to the transformation
we have
(46)
From the equalities (45), (46) it follows that
(47)
Theorem 2 is proved. □
Theorem 3. On the probability space
with the filtration
on it, let
be a complete separable metric space. Suppose that
is a nonnegative integrable
-measurable random value, satisfying the condition
,
. Then, there exists a
-measurable random value
, depending on
, such that
(48)
Proof. First, let us consider the case
. From Theorem 2, we have the inequality
(49)
where
,
.
Let us denote
. Then, the formula (49) is written in the form
(50)
From the inequalities (50), we obtain the inequalities
(51)
(52)
Two cases are possible: a) for all
,
; b) there exists
such that
. First, let us consider the case a).
Since the inequalities (51) are valid for every value
, as
, and
,
, then, if to denote
(53)
we have
and
(54)
From the definition of
, we obtain the inequalities
(55)
Now, if
for some
, then in this case
. All these inequalities give the inequalities
(56)
Consider the case b). From the inequality (51), we obtain the inequalities
(57)
(58)
The inequalities (57) give the inequalities
(59)
Let us define
. Then, from (57) we obtain the inequalities
(60)
From the definition of
, we have the inequalities
(61)
The inequalities (60), (61) give the inequalities
(62)
Theorem 3 in the case
is proved, since the set
has the probability one.
Now let us consider the case of arbitrary
. In this case we have the inequality
(63)
Let us put in this inequality
, then the inequality (63) is transformed into the inequality
(64)
Taking into account the first part of the proof of Theorem 3 from the inequality (64) we obtain
(65)
where the constant
is the same as in the first part of the proof of Theorem 3. Theorem 3 is completely proved. □
Theorem 4. On the probability space
with the filtration
on it, let
be a complete separable metric space. Then, every nonnegative super- martingale
is a local regular one, that is, the optional decomposition for it is valid.
Proof. Without loss of generality, we assume that
. From the last fact, we obtain
(66)
The inequalities (66) and Theorems 3, 4 [1], [17] prove Theorem 4. □
Theorem 5. On the probability space
with the filtration
on it, let
be a complete separable metric space. Then, every bounded from below super-martingale
is a local regular one.
Proof. Since the super-martingale
is bounded from below, then there exists a real number
such that
. If to consider the super-martingale
, then all conditions of Theorem 4 are true. Theorem 5 is proved. □
Theorem 6. On the probability space
with the filtration
on it, let
be a complete separable metric space. Suppose that the evolution of the risk asset is defined by the formula (2) and the non risk asset evolve by the law
,
. If the nonnegative payoff function
is
measurable integrable random value relative to every martingale measure and satisfying the conditions Theorem 16 from [17], then the fair price of super-hedge is given by the formula
(67)
3. Interval of Non-Arbitrage Prices for a Wide Class of Evolutions of Risky Assets
In the papers [2], [3] the range of non arbitrage prices are established. In the paper [2], for the Levy exponential model, the price of super-hedge for call option coincides with the price of the underlying asset under the assumption that the Levy process has unlimited variation, does not contain a Brownian component, with negative jumps of arbitrary magnitude. The same result is true obtained in the paper [3] if the process describing the evolution of the underlying asset is a diffusion process with the jumps described by Poisson jump process. In these papers the evolution is described by continuous processes. Below we consider the discrete evolution of risky assets that is more realistic from the practical point of view.
Theorem 7. On the probability space
, where
is a separable metric space,
is a Borel σ-algebra on
,
is a probability measure on
, let the random values
,
, satisfies the conditions:
1)
, there exists
and
such that
,
,
;
2) for every
,
,
.
Suppose that the evolution of risk asset is given by the formula (2) with
, where
, and on the probability space
, the random value
has the same distribution law as the random value
,
, on the probability space
. If the nonnegative payoff function
,
, satisfies the conditions:
1)
, then
(68)
If, in addition, the nonnegative payoff function
is a convex down one, then
(69)
where M is the set of equivalent martingale measures for the evolution of risk asset
. The interval of non-arbitrage prices of contingent liability
coincides with the set
.
Proof. Due to Theorem 1 and 6 we have
(70)
where
(71)
and we used the denotations
,
,
,
,
. From the inequality
we have
(72)
To prove the inverse inequality we use the inequality
(73)
Therefore, putting in the inequality (73)
we obtain
(74)
Let us prove the equality (69). Using Jensen inequality [18] we obtain
(75)
Let us prove the inverse inequality
(76)
Putting in this inequality
we obtain the needed. The last statement about the interval of non-arbitrage prices follows from [11] and [12]. Theorem 7 is proved. □
Theorem 8. On the probability space
, where
is a separable metric space,
is a Borel σ-algebra on
,
is a probability measure on
, let the random values
,
, satisfies the conditions:
1)
, there exists
and
such that
,
,
;
2) for every
,
.
Suppose that the evolution of risk asset is given by the formula (2) with
, where
, and on the probability space
, the random value
has the same distribution law as the random value
,
, on the probability space
. If the nonnegative payoff function
,
, satisfies the conditions:
1)
,
, then
(77)
If, in addition, the nonnegative payoff function
is a convex down one, then
(78)
where M is the set of equivalent maqtingale measures for the evolution of risk asset
. The interval of non-arbitrage prices of contingent liability
coincides with the set
.
Proof. It is evident that
(79)
Since
(80)
we have
(81)
Therefore, putting in the inequality (81)
we obtain
(82)
Let us prove the equality (78). Due to convexity of payoff function
, using Jensen inequality we obtain
(83)
Let us prove the inverse inequality
(84)
Putting in this inequality
we obtain the needed. Theorem 8 is proved.
□
Remark 3. The results obtained in Theorems 7, 8 are true if for some
,
.
Let us give an example of application of the results obtained. Denote
standard Brownian motion on the time interval
with
. Due to the continuity of
the Winer measure P is concentrated
on the Banach space
with the norm
,
. The space
is a complete separable metric space in the metric generated by the introduced norm. Suppose that
. On the probability space
, where
,
is a Borel σ-algebra on
,
is a probability measure on
, let us consider the random values
,
, where
,
. The random values
,
, are independent between themselves.
The random values
,
, generate the evolution of risk asset given by the formula
,
. Such evolution satisfies the conditions of the Theorems 7, 8.
4. Models of Evolution of Risky Assets Based on the Discrete Geometric Brownian Motion
Suppose that the set
belongs to
with
not depending on the index i.
On the probability space
, considered in the previous example, let us consider the sequence of random values
(85)
where
is a standard Brownian motion with
,
. With every sequence real numbers
,
,
, let us connect the random process
(86)
Below we construct the probability space
and the random process
,
, on it, which is equivalent one in the wide sense to the process (86). For this purpose we could do it using the method, presented in section 2. But for further applications, it is more convenient to construct the simple probability space
and the random process on it, which is equivalent in the wide sense to the process (86).
Let
,
, where
is a real axis,
is a Borel σ-algebra on
. Let us put
,
,
, and let us construct the direct product of the measurable spaces
,
. Denote
. Under the σ-algebra
on
, we understand the minimal σ-algebra generated by sets
. On the measurable space
, under the filtration
we understand the minimal σ-algebra, generated by sets
, where
for
. Suppose that the points
,
, belongs to
with
not depending on the index i. Let us consider the probability space
, where
,
,
,
(87)
On the probability space
, let us consider the evolution of risk asset given by the law
(88)
where
,
, are the same constants, that figure in the formula (86),
,
.
On the probability space
, the random process given by the formula (88) is equivalent in the wide sense to the process (86), constructed above.
Described in Lemma 5 [1] the set of measures Q on the probability space
, which are equivalent to the measure
and such that
, we denote by
.
On the measurable space
, we introduce into consideration the set of measures
, described in Theorem 1 for
,
.
Theorem 9. On the measurable space
with the filtration
,
, on it, let the risk asset evolution is given by the formula (88). For the nonnegative payoff function
, satisfying the condition
, the fair price of super-hedge is given by the formula
(89)
where we put
.
Proof. The proof of Theorem 9 follows directly from Theorem 6. □
Theorem 10. Suppose that the evolution of risk asset is given by the formula (88). If the nonnegative payoff function
,
, satisfies the conditions:
1)
, then
(90)
If, in addition, the nonnegative payoff function
is a convex down one, then
(91)
where
is the set of equivalent martingale measures for the evolution of risk asset
.
Proof. As before,
(92)
Applying
times the inequality (92) we obtain
(93)
Let us prove the equality (91). Using Jensen inequality we obtain
(94)
It is evident the inequality
(95)
Putting in the inequality (95)
we obtain the inverse inequality. □
Theorem 11. Suppose that the evolution of risk asset is given by the formula (88). If the nonnegative payoff function
,
, satisfies the conditions:
1)
, then
(96)
If, in addition, the nonnegative payoff function
is a convex down one, then
(97)
where
is the set of equivalent martingale measures for the evolution of risk asset
.
Proof. Let us obtain the estimate from below. Really,
(98)
Applying
times the inequality (98) we obtain the needed inequality
(99)
Let us prove the equality (97). Using Jensen inequality we obtain
(100)
It is evident the inequality
(101)
Putting in the inequality (101)
we obtain the inverse inequality. □
Theorem 12. On the measurable space
with the filtration
,
, on it, let the discount risk asset evolution is given by the formula (88) with
,
, For the payoff function
,
,
, the fair price of super-hedge is given by the formula
(102)
If
, then the set of non arbitrage prices coincides with the point
, in case if
the set of non arbitrage prices coincides with the interval
.
Proof. Let us introduce the denotations
(103)
(104)
(105)
where we put
.
Let us estimate from above the value
(106)
For this we use the equality
(107)
which follows from the identity:
,
. Since
(108)
we obtain the inequality
(109)
From the inequality (109) we have
(110)
Due to the inequality (90) of Theorem 10
(111)
and the inequality
(112)
which follows from Jensen inequality, we have
(113)
This proves Theorem 12. □
Theorem 13. On the measurable space
with the filtration
,
, on it, let the discount risk asset evolution is given by the formula (88), with
,
. For the payoff function
,
,
, the fair price of super-hedge is given by the formula
(114)
The set of non arbitrage prices coincides with the set
.
Proof. The inequality
(115)
is true. Taking into account the inequality (96) of Theorem 11 we prove Theorem 13. □
Theorem 14. On the measurable space
with the filtration
,
, on it, let the discount risk asset evolution is given by the formula (88) with
,
. For the payoff function
,
, the fair price of super-hedge is given by the formula
(116)
The set of non arbitrage prices coincides with the set
, if
. For
the set of non arbitrage prices coincides with the point 0.
Proof. It is evident that
(117)
Let us prove the inverse inequality. We have
(118)
Therefore,
(119)
The inequalities (117), (119) prove Theorem 14. □
Theorem 15. On the measurable space
with the filtration
,
, on it, let the discount risk asset evolution is given by the formula (88) with
,
. For the payoff function
,
, the fair price of super-hedge is given by the formula
(120)
If
, then the set of non arbitrage prices coincides with the point
, in case if
the set of non arbitrage prices coincides with the interval
.
Proof. We have