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Mars
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 4:48 pm

(3) is not a premiss. As I said B&S model => PDE => expectation with a specific measure coming from Feynmann-Kac theorem => (3) is true with the expectation using the same measure.

And in that model there are risk premiums.
Thanks. Are there any simpler ways to derive the Formula direct from the BS PDE? And how to derive without any appeal to expectations at all?
You can solve it by change of variable to get heat equation which give you the B&S solution. Indeed In what I said we got PDE first then "Expectations" comes from Feynmann-Kac Theorem. And then come your equation(1), which use expectation without being clear on what it means. Using Feynmann-Kac make it crystal clear in my opinion.
 
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complyorexplain
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 4:48 pm

Don't drag me into your wikipedia logic drivel, please.
OK is Wolfram better? https://mathworld.wolfram.com/Validity.html
 
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Paul
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 7:02 pm

Girsanov isn't particularly useful, in my opinion.

Change of measure = change of variables. The latter you do in high school. The former is just a complicated presentation of the latter in a very narrow field to make it palatable for university professor probabilists to teach.

Assumptions hint at a model. 

Randomness in model makes people worried about how to value risky things. E.g. expectations might not play a simple role.

Assumptions +model +hedging + no arbitrage => BS PDE, Binomial model, ...

Trivial observation about BS PDE or binomial model shows that there is a role for simple expectations. 

That role is to pretend that assets all have the same rate of return. Even though they don't. This is risk neutrality.

Probabilists get all aroused. Trivial things gets messy.

As to derivation of BS formulae, there are many ways that are equally simple.

The role of expectations also has the result that values can be found by simulations, Monte Carlo. Very useful.

But risk neutrality distracts from reality. It's a very tempting dead end, but with lots of drink, drugs, free love. 



  
 
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Cuchulainn
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 7:54 pm

But risk neutrality distracts from reality. It's a very tempting dead end, but with lots of drink, drugs, free love. 

Sounds very 70s.
"Can't buy me love,no, no, no,no,no"

// You can stare at an SDE all day long [$]^*[$] (some people do) but when you stare at a PDE then at some stage the solution jumps off the page.

[$]^*[$] converging a.s./p.p.to Euler method. Every time. Without fail.
Last edited by Cuchulainn on December 21st, 2020, 8:23 pm, edited 2 times in total.
 
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katastrofa
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 8:17 pm

Don't drag me into your wikipedia logic drivel, please.
OK is Wolfram better? https://mathworld.wolfram.com/Validity.html
No online resources can replace a book. For you, Shreve.

Paul: "Change of measure = change of variables."

In infinite number of dimensions.
 
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Cuchulainn
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 8:24 pm

dbl
Last edited by Cuchulainn on December 21st, 2020, 8:30 pm, edited 1 time in total.
 
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Cuchulainn
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 8:28 pm



In infinite number of dimensions.
Bad news, kats. The only Borel measure on a Banach space is the trivial measure. 

https://en.wikipedia.org/wiki/Infinite- ... ue_measure

That's an Ecumenical matter.


Not that anyone would want to do that.
 
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Paul
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 8:47 pm

Don't drag me into your wikipedia logic drivel, please.
OK is Wolfram better? https://mathworld.wolfram.com/Validity.html
No online resources can replace a book. For you, Shreve.

Paul: "Change of measure = change of variables."

In infinite number of dimensions.
I actually meant change of numeraire. But am very happy that you didn’t find fault with anything else!!!
 
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katastrofa
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 10:44 pm

I didn't mean to indicate any faults. My intention was to complete your abstract statement. I appreciate that you talk about mathematics at such a high level, especially in the context of an applied quantitative field.
 
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Paul
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 11:07 pm

My intention is always to speak at the optimal level!
 
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katastrofa
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 11:38 pm

Of course. That's why you jump on the desk.
 
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Paul
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Re: Proof of the risk-neutral assumption

December 21st, 2020, 11:52 pm

You’ve seen me lecture on finite differences then? I climb up on furniture to explain the forward, backward and central differences.

I also find that wives are a great source of useful analogies.
 
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Cuchulainn
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Re: Proof of the risk-neutral assumption

December 22nd, 2020, 12:17 am

You’ve seen me lecture on finite differences then? I climb up on furniture to explain the forward, backward and central differences.

I also find that wives are a great source of useful analogies.
I use ADE method.
 
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katastrofa
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Re: Proof of the risk-neutral assumption

December 23rd, 2020, 1:26 pm

I saw a cute Maxwell demon increasing the Helmholtz energy to fuel his teaching efforts. And Cuchulainn is a buzzing Brownian computer. I'll always see the world with physicist's eyes!

Isn't it funny that the same mathematical theory and tools (theory of stochastic processes, Girsanov, Feynman-Kac, Fokker-Planck, Lie Trotter ...) work for a simple ferromagnet, DNA replication, derivative proving and more. Too beautiful to be true.
 
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Cuchulainn
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Re: Proof of the risk-neutral assumption

December 23rd, 2020, 1:40 pm

Lie Trotter .

Just so happens that I am implementing  LT as we speak. It's first-order. or 2nd order, go for Strang-Marchuk operator Splitting. Nice thing is splitting {diffusion, convection}, {potential, kinetic energy} and not {x,y}.

Wow! I didnie know you physicists knew BCH et al.

https://www.asc.tuwien.ac.at/~ewa/semin ... ag_Exl.pdf