Purely Discontinuous Local Martingales

The previous post introduced the idea of a purely discontinuous local martingale. In the context of that post, such processes were used to construct local martingales with prescribed jumps, and enabled us to obtain uniqueness in the constructions given there. However, purely discontinuous local martingales are a very useful concept more generally in martingale and semimartingale theory, so I will go into more detail about such processes now. To start, we restate the definition from the previous post.

Definition 1 A local martingale X is said to be purely discontinuous iff XM is a local martingale for all continuous local martingales M.

We can show that every local martingale decomposes uniquely into continuous and purely discontinuous parts. Continuous local martingales are well understood — for instance, they can always be realized as time-changed Brownian motions. On the other hand, as we will see in a moment, purely discontinuous local martingales can be realized as limits of FV processes, and arguments involving FV local martingales can often to be extended to the purely discontinuous case. So, decomposition (1) below is useful as it allows arguments involving continuous-time local martingales to be broken down into different approaches involving their continuous and purely discontinuous parts. As always, two processes are considered to be equal if they are equivalent up to evanescence.

Theorem 2 Every local martingale X decomposes uniquely as

$\displaystyle X = X^{\rm c} + X^{\rm d}$ (1)

where ${X^{\rm c}}$ is a continuous local martingale with ${X^{\rm c}_0=0}$ and ${X^{\rm d}}$ is a purely discontinuous local martingale.

Proof: As the process ${H=\Delta X}$ is, by definition, equal to the jump process of a local martingale then it satisfies the hypothesis of Theorem 5 of the previous post. So, there exists a purely discontinuous local martingale ${X^{\rm d}}$ with ${\Delta X^{\rm d}=H=\Delta X}$ . We can take ${X^{\rm d}_0=X_0}$ so that ${X^{\rm c}=X-X^{\rm d}}$ is a continuous local martingale starting from 0.

If ${X=\tilde X^{\rm c}+\tilde X^{\rm d}}$ is another such decomposition, then ${\tilde X^{\rm d}}$ and ${X^{\rm d}}$ have the same jumps and initial value so, by Lemma 3 of the previous post, ${\tilde X^{\rm d}=X^{\rm d}}$ . ⬜

Throughout the remainder of this post, the notation ${X^{\rm c}}$ and ${X^{\rm d}}$ will be used to denote the continuous and purely discontinuous parts of a local martingale X, as given by decomposition (1). Using the notation ${\mathcal{M}_{\rm loc}}$ , ${\mathcal{M}_{{\rm loc},0}^{\rm c}}$ and ${\mathcal{M}_{\rm loc}^{\rm d} }$ respectively for the spaces of local martingales, continuous local martingales starting from zero and the purely discontinuous local martingales, Theorem 2 can be expressed succinctly as

$\displaystyle \mathcal{M}_{\rm loc} = \mathcal{M}_{{\rm loc},0}^{\rm c} \oplus \mathcal{M}_{\rm loc}^{\rm d}.$

(2)

That is, ${\mathcal{M}_{\rm loc}}$ is the direct sum of ${\mathcal{M}_{{\rm loc},0}^{\rm c}}$ and ${\mathcal{M}_{\rm loc}^{\rm d}}$ . Definition 2 identifies the purely discontinuous local martingales to be, in a sense, orthogonal to the continuous local martingales. Then, (2) can be understood as the decomposition of ${\mathcal{M}_{\rm loc}}$ into the direct sum of the closed subspace ${\mathcal{M}_{{\rm loc},0}^{\rm c}}$ and its orthogonal complement. This does in fact give an alternative, elementary, and commonly used, method of proving decomposition (1). As we have already shown the rather strong result of Theorem 5 from the previous post, the quickest way of proving the decomposition was to simply apply this result. I’ll give more details on the more elementary approach further below.

Definition 1 used above for the class of purely discontinuous local martingales was very convenient for our purposes, as it leads immediately to the proof of Theorem 2. However, there are many alternative characterizations of such processes. For example, they are precisely the processes which are limits of FV local martingales in a strong enough sense. They can also be characterized in terms of their quadratic variations and covariations. Recall that the quadratic variation and covariation are FV processes with jumps ${\Delta[X]=(\Delta X)^2}$ and ${\Delta[X,Y]=\Delta X\Delta Y}$ , so that they can be decomposed into continuous and pure jump components,

$\displaystyle \setlength\arraycolsep{2pt} \begin{array}{rl} \displaystyle [X]_t &\displaystyle=[X]^c_t+\sum_{s\le t}(\Delta X_s)^2,\smallskip\\ \displaystyle [X,Y]_t &\displaystyle=[X,Y]^c_t+\sum_{s\le t}\Delta X_s\Delta Y_s. \end{array}$

(3)

The following theorem gives several alternative characterizations of the class of purely discontinuous local martingales.

Theorem 3 For a local martingale X, the following are equivalent.

X is purely discontinuous.

${[X,Y]=0}$ for all continuous local martingales Y.

${[X,Y]^c=0}$ for all local martingales Y.

${[X]^c=0}$ .

there exists a sequence ${\{X^n\}_{n=1,2,\ldots}}$ of FV local martingales such that
$\displaystyle {\mathbb E}\left[\sup_{t\ge0}(X^n_t-X_t)^2\right]\rightarrow0.$

Continue reading “Purely Discontinuous Local Martingales” →

Constructing Martingales with Prescribed Jumps

In this post we will describe precisely which processes can be realized as the jumps of a local martingale. This leads to very useful decomposition results for processes — see Theorem 10 below, where we give a decomposition of a process X into martingale and predictable components. As I will explore further in future posts, this enables us to construct particularly useful decompositions for local martingales and semimartingales.

Before going any further, we start by defining the class of local martingales which will be used to match prescribed jump processes. The purely discontinuous local martingales are, in a sense, the orthogonal complement to the class of continuous local martingales.

Definition 1 A local martingale X is said to be purely discontinuous iff XM is a local martingale for all continuous local martingales M.

The class of purely discontinuous local martingales is often denoted as ${\mathcal{M}_{\rm loc}^{\rm d}}$ . Clearly, any linear combination of purely discontinuous local martingales is purely discontinuous. I will investigate ${\mathcal{M}_{\rm loc}^{\rm d}}$ in more detail later but, in order that we do have plenty of examples of such processes, we show that all FV local martingales are purely discontinuous.

Lemma 2 Every FV local martingale is purely discontinuous.

Proof: If X is an FV local martingale and M is a continuous local martingale then we can compute the quadratic covariation,

$\displaystyle [X,M]_t=\sum_{s\le t}\Delta X_s\Delta M_s=0.$

The first equality follows because X is an FV process, and the second because M is continuous. So, ${XM=XM-[X,M]}$ is a local martingale and X is purely discontinuous. ⬜

Next, an important property of purely discontinuous local martingales is that they are determined uniquely by their jumps. Throughout these notes, I am considering two processes to be equal whenever they are equal up to evanescence.

Lemma 3 Purely discontinuous local martingales are uniquely determined by their initial value and jumps. That is, if X and Y are purely discontinuous local martingales with ${X_0=Y_0}$ and ${\Delta X = \Delta Y}$ , then ${X=Y}$ .

Proof: Setting ${M=X-Y}$ we have ${M_0=0}$ and ${\Delta M = 0}$ . So, M is a continuous local martingale and ${M^2= MX-MY}$ is a local martingale starting from zero. Hence, it is a supermartingale and we have

$\displaystyle {\mathbb E}[M_t^2]\le{\mathbb E}[M_0^2]=0.$

So ${M_t=0}$ almost surely and, by right-continuity, ${M=0}$ up to evanescence. ⬜

Note that if X is a continuous local martingale, then the constant process ${Y_t=X_0}$ has the same initial value and jumps as X. So Lemma 3 has the immediate corollary.

Corollary 4 Any local martingale which is both continuous and purely discontinuous is almost surely constant.

Recalling that the jump process, ${\Delta X}$ , of a cadlag adapted process X is thin, we now state the main theorem of this post and describe precisely those processes which occur as the jumps of a local martingale.

Theorem 5 Let H be a thin process. Then, ${H=\Delta X}$ for a local martingale X if and only if

${\sqrt{\sum_{s\le t}H_s^2}}$ is locally integrable.

${{\mathbb E}[1_{\{\tau < \infty\}}H_\tau\;\vert\mathcal{F}_{\tau-}]=0}$ (a.s.) for all predictable stopping times ${\tau}$ .

Furthermore, X can be chosen to be purely discontinuous with ${X_0=0}$ , in which case it is unique.

Continue reading “Constructing Martingales with Prescribed Jumps” →

The Doob-Meyer Decomposition for Quasimartingales

As previously discussed, for discrete-time processes the Doob decomposition is a simple, but very useful, technique which allows us to decompose any integrable process into the sum of a martingale and a predictable process. If ${\{X_n\}_{n=0,1,2,\ldots}}$ is an integrable discrete-time process adapted to a filtration ${\{\mathcal{F}_n\}_{n=0,1,2,\ldots}}$ , then the Doob decomposition expresses X as

$\displaystyle \setlength\arraycolsep{2pt} \begin{array}{rl} \displaystyle X_n&\displaystyle=M_n+A_n,\smallskip\\ \displaystyle A_n&\displaystyle=\sum_{k=1}^n{\mathbb E}\left[X_k-X_{k-1}\;\vert\mathcal{F}_{k-1}\right]. \end{array}$

(1)

Then, M is then a martingale and A is an integrable process which is also predictable, in the sense that ${A_n}$ is ${\mathcal{F}_{n-1}}$ -measurable for each ${n > 0}$ . The expected value of the variation of A can be computed in terms of X,

$\displaystyle {\mathbb E}\left[\sum_{k=1}^n\lvert A_k-A_{k-1}\rvert\right] ={\mathbb E}\left[\sum_{k=1}^n\left\lvert {\mathbb E}[X_k-X_{k-1}\vert\;\mathcal{F}_{k-1}]\right\rvert\right].$

This is the mean variation of X.

In continuous time, the situation is rather more complex, and will require constraints on the process X other than just integrability. We have already discussed the case for submartingales — the Doob-Meyer decomposition. This decomposes a submartingale into a local martingale and a predictable increasing process.

A natural setting for further generalising the Doob-Meyer decomposition is that of quasimartingales. In continuous time, the appropriate class of processes to use for the component A of the decomposition is the predictable FV processes. Decomposition (2) below is the same as that in the previous post on special semimartingales. This is not surprising, as we have already seen that the class of special semimartingales is identical to the class of local quasimartingales. The difference with the current setting is that we can express the expected variation of A in terms of the mean variation of X, and obtain a necessary and sufficient condition for the local martingale component to be a proper martingale.

As was noted in an earlier post, historically, decomposition (2) for quasimartingales played an important part in the development of stochastic calculus and, in particular, in the proof of the Bichteler-Dellacherie theorem. That is not the case in these notes, however, as we have already proven the main results without requiring quasimartingales. As always, any two processes are identified whenever they are equivalent up to evanescence.

Theorem 1 Every cadlag quasimartingale X uniquely decomposes as

$\displaystyle X=M+A$ (2)

where M is a local martingale and A is a predictable FV process with ${A_0=0}$ . Then, A has integrable variation over each finite time interval ${[0,t]}$ satisfying

$\displaystyle {\rm Var}_t(X)={\rm Var}_t(M)+{\mathbb E}\left[\int_0^t\,\vert dA\vert\right].$ (3)

so that, in particular,

$\displaystyle {\mathbb E}\left[\int_0^t\,\vert dA\vert\right]\le{\rm Var}_t(X).$ (4)

Furthermore, the following are equivalent,

X is of class (DL).

M is a proper martingale.

inequality (4) is an equality for all times t.

Continue reading “The Doob-Meyer Decomposition for Quasimartingales” →

Properties of Quasimartingales

The previous two posts introduced the concept of quasimartingales, and noted that they can be considered as a generalization of submartingales and supermartingales. In this post we prove various basic properties of quasimartingales and of the mean variation, extending results of martingale theory to this situation.

We start with a version of optional stopping which applies for quasimartingales. For now, we just consider simple stopping times, which are stopping times taking values in a finite subset of the nonnegative extended reals ${\bar{\mathbb R}_+=[0,\infty]}$ . Stopping a process can only decrease its mean variation (recall the alternative definitions ${{\rm Var}}$ and ${{\rm Var}^*}$ for the mean variation). For example, a process X is a martingale if and only if ${{\rm Var}(X)=0}$ , so in this case the following result says that stopped martingales are martingales.

Lemma 1 Let X be an adapted process and ${\tau}$ be a simple stopping time. Then

$\displaystyle {\rm Var}^*(X^\tau)\le{\rm Var}^*(X).$ (1)

Assuming, furthermore, that X is integrable,

$\displaystyle {\rm Var}(X^\tau)\le{\rm Var}(X).$ (2)

and, more precisely,

$\displaystyle {\rm Var}(X)={\rm Var}(X^\tau)+{\rm Var}(X-X^\tau)$ (3)

Continue reading “Properties of Quasimartingales” →

Rao’s Quasimartingale Decomposition

In this post I’ll give a proof of Rao’s decomposition for quasimartingales. That is, every quasimartingale decomposes as the sum of a submartingale and a supermartingale. Equivalently, every quasimartingale is a difference of two submartingales, or alternatively, of two supermartingales. This was originally proven by Rao (Quasi-martingales, 1969), and is an important result in the general theory of continuous-time stochastic processes.

As always, we work with respect to a filtered probability space ${(\Omega,\mathcal{F},\{\mathcal{F}_t\}_{t\ge0},{\mathbb P})}$ . It is not required that the filtration satisfies either of the usual conditions — the filtration need not be complete or right-continuous. The methods used in this post are elementary, requiring only basic measure theory along with the definitions and first properties of martingales, submartingales and supermartingales. Other than referring to the definitions of quasimartingales and mean variation given in the previous post, there is no dependency on any of the general theory of semimartingales, nor on stochastic integration other than for elementary integrands.

Recall that, for an adapted integrable process X, the mean variation on an interval ${[0,t]}$ is

$\displaystyle {\rm Var}_t(X)=\sup{\mathbb E}\left[\int_0^t\xi\,dX\right],$

where the supremum is taken over all elementary processes ${\xi}$ with ${\vert\xi\vert\le1}$ . Then, X is a quasimartingale if and only if ${{\rm Var}_t(X)}$ is finite for all positive reals t. It was shown that all supermartingales are quasimartingales with mean variation given by

$\displaystyle {\rm Var}_t(X)={\mathbb E}\left[X_0-X_t\right].$

(1)

Rao’s decomposition can be stated in several different ways, depending on what conditions are required to be satisfied by the quasimartingale X. As the definition of quasimartingales does differ between texts, there are different versions of Rao’s theorem around although, up to martingale terms, they are equivalent. In this post, I’ll give three different statements with increasingly stronger conditions for X. First, the following statement applies to all quasimartingales as defined in these notes. Theorem 1 can be compared to the Jordan decomposition, which says that any function ${f\colon{\mathbb R}_+\rightarrow{\mathbb R}}$ with finite variation on bounded intervals can be decomposed as the difference of increasing functions or, equivalently, of decreasing functions. Replacing finite variation functions by quasimartingales and decreasing functions by supermartingales gives the following.

Theorem 1 (Rao) A process X is a quasimartingale if and only if it decomposes as

$\displaystyle X=Y-Z$ (2)

for supermartingales Y and Z. Furthermore,

this decomposition can be done in a minimal sense, so that if ${X=Y^\prime-Z^\prime}$ is any other such decomposition then ${Y^\prime-Y=Z^\prime-Z}$ is a supermartingale.

the inequality

$\displaystyle {\rm Var}_t(X)\le{\mathbb E}[Y_0-Y_t]+{\mathbb E}[Z_0-Z_t],$ (3)

holds, with equality for all ${t\ge0}$ if and only if the decomposition is minimal.

the minimal decomposition is unique up to a martingale. That is, if ${X=Y-Z=Y^\prime-Z^\prime}$ are two such minimal decompositions, then ${Y^\prime-Y=Z^\prime-Z}$ is a martingale.

Continue reading “Rao’s Quasimartingale Decomposition” →

Quasimartingales

Quasimartingales are a natural generalization of martingales, submartingales and supermartingales. They were first introduced by Fisk in order to extend the Doob-Meyer decomposition to a larger class of processes, showing that continuous quasimartingales can be decomposed into martingale and finite variation terms (Quasi-martingales, 1965). This was later extended to right-continuous processes by Orey (F-Processes, 1967). The way in which quasimartingales relate to sub- and super-martingales is very similar to how functions of finite variation relate to increasing and decreasing functions. In particular, by the Jordan decomposition, any finite variation function on an interval decomposes as the sum of an increasing and a decreasing function. Similarly, a stochastic process is a quasimartingale if and only if it can be written as the sum of a submartingale and a supermartingale. This important result was first shown by Rao (Quasi-martingales, 1969), and means that much of the theory of submartingales can be extended without much work to also cover quasimartingales.

Often, given a process, it is important to show that it is a semimartingale so that the techniques of stochastic calculus can be applied. If there is no obvious decomposition into local martingale and finite variation terms, then, one way of doing this is to show that it is a quasimartingale. All right-continuous quasimartingales are semimartingales. This result is also important in the general theory of semimartingales with, for example, many proofs of the Bichteler-Dellacherie theorem involving quasimartingales.

In this post, I will mainly be concerned with the definition and very basic properties of quasimartingales, and look at the more advanced theory in the following post. We work with respect to a filtered probability space ${(\Omega,\mathcal{F},\{\mathcal{F}_t\}_{t\ge0},{\mathbb P})}$ . It is not necessary to assume that either of the usual conditions, of right-continuity or completeness, hold. First, the mean variation of a process is defined as follows.

Definition 1 The mean variation of an integrable stochastic process X on an interval ${[0,t]}$ is

$\displaystyle {\rm Var}_t(X)=\sup{\mathbb E}\left[\sum_{k=1}^n\left\vert{\mathbb E}\left[X_{t_k}-X_{t_{k-1}}\;\vert\mathcal{F}_{t_{k-1}}\right]\right\vert\right].$ (1)

Here, the supremum is taken over all finite sequences of times,

$\displaystyle 0=t_0\le t_1\le\cdots\le t_n=t.$

A quasimartingale, then, is a process with finite mean variation on each bounded interval.

Definition 2 A quasimartingale, X, is an integrable adapted process such that ${{\rm Var}_t(X)}$ is finite for each time ${t\in{\mathbb R}_+}$ .

Continue reading “Quasimartingales” →

The Doob-Meyer Decomposition

The Doob-Meyer decomposition was a very important result, historically, in the development of stochastic calculus. This theorem states that every cadlag submartingale uniquely decomposes as the sum of a local martingale and an increasing predictable process. For one thing, if X is a square-integrable martingale then Jensen’s inequality implies that ${X^2}$ is a submartingale, so the Doob-Meyer decomposition guarantees the existence of an increasing predictable process ${\langle X\rangle}$ such that ${X^2-\langle X\rangle}$ is a local martingale. The term ${\langle X\rangle}$ is called the predictable quadratic variation of X and, by using a version of the Ito isometry, can be used to define stochastic integration with respect to square-integrable martingales. For another, semimartingales were historically defined as sums of local martingales and finite variation processes, so the Doob-Meyer decomposition ensures that all local submartingales are also semimartingales. Going further, the Doob-Meyer decomposition is used as an important ingredient in many proofs of the Bichteler-Dellacherie theorem.

The approach taken in these notes is somewhat different from the historical development, however. We introduced stochastic integration and semimartingales early on, without requiring much prior knowledge of the general theory of stochastic processes. We have also developed the theory of semimartingales, such as proving the Bichteler-Dellacherie theorem, using a stochastic integration based method. So, the Doob-Meyer decomposition does not play such a pivotal role in these notes as in some other approaches to stochastic calculus. In fact, the special semimartingale decomposition already states a form of the Doob-Meyer decomposition in a more general setting. So, the main part of the proof given in this post will be to show that all local submartingales are semimartingales, allowing the decomposition for special semimartingales to be applied.

The Doob-Meyer decomposition is especially easy to understand in discrete time, where it reduces to the much simpler Doob decomposition. If ${\{X_n\}_{n=0,1,2,\ldots}}$ is an integrable discrete-time process adapted to a filtration ${\{\mathcal{F}_n\}_{n=0,1,2,\ldots}}$ , then the Doob decomposition expresses X as

(1)

As previously discussed, M is then a martingale and A is an integrable process which is also predictable, in the sense that ${A_n}$ is ${\mathcal{F}_{n-1}}$ -measurable for each ${n > 0}$ . Furthermore, X is a submartingale if and only if ${{\mathbb E}[X_n-X_{n-1}\vert\mathcal{F}_{n-1}]\ge0}$ or, equivalently, if A is almost surely increasing.

Moving to continuous time, we work with respect to a complete filtered probability space ${(\Omega,\mathcal{F},\{\mathcal{F}_t\}_{t\ge0},{\mathbb P})}$ with time index t ranging over the nonnegative real numbers. Then, the continuous-time version of (1) takes A to be a right-continuous and increasing process which is predictable, in the sense that it is measurable with respect to the σ-algebra generated by the class of left-continuous and adapted processes. Often, the Doob-Meyer decomposition is stated under additional assumptions, such as X being of class (D) or satisfying some similar uniform integrability property. To be as general possible, the statement I give here only requires X to be a local submartingale, and furthermore states how the decomposition is affected by various stronger hypotheses that X may satisfy.

Theorem 1 (Doob-Meyer) Any local submartingale X has a unique decomposition

$\displaystyle X=M+A,$ (2)

where M is a local martingale and A is a predictable increasing process starting from zero.

Furthermore,

if X is a proper submartingale, then A is integrable and satisfies

$\displaystyle {\mathbb E}[A_\tau]\le{\mathbb E}[X_\tau-X_0]$ (3)

for all uniformly bounded stopping times ${\tau}$ .

X is of class (DL) if and only if M is a proper martingale and A is integrable, in which case

$\displaystyle {\mathbb E}[A_\tau]={\mathbb E}[X_\tau-X_0]$ (4)

for all uniformly bounded stopping times ${\tau}$ .

X is of class (D) if and only if M is a uniformly integrable martingale and ${A_\infty}$ is integrable. Then, ${X_\infty=\lim_{t\rightarrow\infty}X_t}$ and ${M_\infty=\lim_{t\rightarrow\infty}M_t}$ exist almost surely, and (4) holds for all (not necessarily finite) stopping times ${\tau}$ .

Continue reading “The Doob-Meyer Decomposition” →

Compensators of Counting Processes

A counting process, X, is defined to be an adapted stochastic process starting from zero which is piecewise constant and right-continuous with jumps of size 1. That is, letting ${\tau_n}$ be the first time at which ${X_t=n}$ , then

$\displaystyle X_t=\sum_{n=1}^\infty 1_{\{\tau_n\le t\}}.$

By the debut theorem, ${\tau_n}$ are stopping times. So, X is an increasing integer valued process counting the arrivals of the stopping times ${\tau_n}$ . A basic example of a counting process is the Poisson process, for which ${X_t-X_s}$ has a Poisson distribution independently of ${\mathcal{F}_s}$ , for all times ${t > s}$ , and for which the gaps ${\tau_n-\tau_{n-1}}$ between the stopping times are independent exponentially distributed random variables. As we will see, although Poisson processes are just one specific example, every quasi-left-continuous counting process can actually be reduced to the case of a Poisson process by a time change. As always, we work with respect to a complete filtered probability space ${(\Omega,\mathcal{F},\{\mathcal{F}_t\}_{t\ge0},{\mathbb P})}$ .

Note that, as a counting process X has jumps bounded by 1, it is locally integrable and, hence, the compensator A of X exists. This is the unique right-continuous predictable and increasing process with ${A_0=0}$ such that ${X-A}$ is a local martingale. For example, if X is a Poisson process of rate ${\lambda}$ , then the compensated Poisson process ${X_t-\lambda t}$ is a martingale. So, the compensator of X is the continuous process ${A_t=\lambda t}$ . More generally, X is said to be quasi-left-continuous if ${{\mathbb P}(\Delta X_\tau=0)=1}$ for all predictable stopping times ${\tau}$ , which is equivalent to the compensator of X being almost surely continuous. Another simple example of a counting process is ${X=1_{[\tau,\infty)}}$ for a stopping time ${\tau > 0}$ , in which case the compensator of X is just the same thing as the compensator of ${\tau}$ .

As I will show in this post, compensators of quasi-left-continuous counting processes have many parallels with the quadratic variation of continuous local martingales. For example, Lévy’s characterization states that a local martingale X starting from zero is standard Brownian motion if and only if its quadratic variation is ${[X]_t=t}$ . Similarly, as we show below, a counting process is a homogeneous Poisson process of rate ${\lambda}$ if and only if its compensator is ${A_t=\lambda t}$ . It was also shown previously in these notes that a continuous local martingale X has a finite limit ${X_\infty=\lim_{t\rightarrow\infty}X_t}$ if and only if ${[X]_\infty}$ is finite. Similarly, a counting process X has finite value ${X_\infty}$ at infinity if and only if the same is true of its compensator. Another property of a continuous local martingale X is that it is constant over all intervals on which its quadratic variation is constant. Similarly, a counting process X is constant over any interval on which its compensator is constant. Finally, it is known that every continuous local martingale is simply a continuous time change of standard Brownian motion. In the main result of this post (Theorem 5), we show that a similar statement holds for counting processes. That is, every quasi-left-continuous counting process is a continuous time change of a Poisson process of rate 1. Continue reading “Compensators of Counting Processes” →

Compensators of Stopping Times

The previous post introduced the concept of the compensator of a process, which is known to exist for all locally integrable semimartingales. In this post, I’ll just look at the very special case of compensators of processes consisting of a single jump of unit size.

Definition 1 Let ${\tau}$ be a stopping time. The compensator of ${\tau}$ is defined to be the compensator of ${1_{[\tau,\infty)}}$ .

So, the compensator A of ${\tau}$ is the unique predictable FV process such that ${A_0=0}$ and ${1_{[\tau,\infty)}-A}$ is a local martingale. Compensators of stopping times are sufficiently special that we can give an accurate description of how they behave. For example, if ${\tau}$ is predictable, then its compensator is just ${1_{\{\tau > 0\}}1_{[\tau,\infty)}}$ . If, on the other hand, ${\tau}$ is totally inaccessible and almost surely finite then, as we will see below, its compensator, A, continuously increases to a value ${A_\infty}$ which has the exponential distribution.

However, compensators of stopping times are sufficiently general to be able to describe the compensator of any cadlag adapted process X with locally integrable variation. We can break X down into a continuous part plus a sum over its jumps,

$\displaystyle X_t=X_0+X^c_t+\sum_{n=1}^\infty\Delta X_{\tau_n}1_{[\tau_n,\infty)}.$

(1)

Here, ${\tau_n > 0}$ are disjoint stopping times such that the union ${\bigcup_n[\tau_n]}$ of their graphs contains all the jump times of X. That they are disjoint just means that ${\tau_m\not=\tau_n}$ whenever ${\tau_n < \infty}$ , for any ${m\not=n}$ . As was shown in an earlier post, not only is such a sequence ${\tau_n}$ of the stopping times guaranteed to exist, but each of the times can be chosen to be either predictable or totally inaccessible. As the first term, ${X^c_t}$ , on the right hand side of (1) is a continuous FV process, it is by definition equal to its own compensator. So, the compensator of X is equal to ${X^c}$ plus the sum of the compensators of ${\Delta X_{\tau_n}1_{[\tau_n,\infty)}}$ . The reduces compensators of locally integrable FV processes to those of processes consisting of a single jump at either a predictable or a totally inaccessible time. Continue reading “Compensators of Stopping Times” →

Compensators

A very common technique when looking at general stochastic processes is to break them down into separate martingale and drift terms. This is easiest to describe in the discrete time situation. So, suppose that ${\{X_n\}_{n=0,1,\ldots}}$ is a stochastic process adapted to the discrete-time filtered probability space ${(\Omega,\mathcal{F},\{\mathcal{F}_n\}_{n=0,1,\ldots},{\mathbb P})}$ . If X is integrable, then it is possible to decompose it into the sum of a martingale M and a process A, starting from zero, and such that ${A_n}$ is ${\mathcal{F}_{n-1}}$ -measurable for each ${n\ge1}$ . That is, A is a predictable process. The martingale condition on M enforces the identity

$\displaystyle A_n-A_{n-1}={\mathbb E}[A_n-A_{n-1}\vert\mathcal{F}_{n-1}]={\mathbb E}[X_n-X_{n-1}\vert\mathcal{F}_{n-1}].$

So, A is uniquely defined by

$\displaystyle A_n=\sum_{k=1}^n{\mathbb E}\left[X_k-X_{k-1}\vert\mathcal{F}_{k-1}\right],$

(1)

and is referred to as the compensator of X. This is just the predictable term in the Doob decomposition described at the start of the previous post.

In continuous time, where we work with respect to a complete filtered probability space ${(\Omega,\mathcal{F},\{\mathcal{F}_t\}_{t\ge0},{\mathbb P})}$ , the situation is much more complicated. There is no simple explicit formula such as (1) for the compensator of a process. Instead, it is defined as follows.

Definition 1 The compensator of a cadlag adapted process X is a predictable FV process A, with ${A_0=0}$ , such that ${X-A}$ is a local martingale.

For an arbitrary process, there is no guarantee that a compensator exists. From the previous post, however, we know exactly when it does. The processes for which a compensator exists are precisely the special semimartingales or, equivalently, the locally integrable semimartingales. Furthermore, if it exists, then the compensator is uniquely defined up to evanescence. Definition 1 is considerably different from equation (1) describing the discrete-time case. However, we will show that, at least for processes with integrable variation, the continuous-time definition does follow from the limit of discrete time compensators calculated along ever finer partitions (see below).

Although we know that compensators exist for all locally integrable semimartingales, the notion is often defined and used specifically for the case of adapted processes with locally integrable variation or, even, just integrable increasing processes. As with all FV processes, these are semimartingales, with stochastic integration for locally bounded integrands coinciding with Lebesgue-Stieltjes integration along the sample paths. As an example, consider a homogeneous Poisson process X with rate ${\lambda}$ . The compensated Poisson process ${M_t=X_t-\lambda t}$ is a martingale. So, X has compensator ${\lambda t}$ .

We start by describing the jumps of the compensator, which can be done simply in terms of the jumps of the original process. Recall that the set of jump times ${\{t\colon\Delta X_t\not=0\}}$ of a cadlag process are contained in the graphs of a sequence of stopping times, each of which is either predictable or totally inaccessible. We, therefore, only need to calculate ${\Delta A_\tau}$ separately for the cases where ${\tau}$ is a predictable stopping time and when it is totally inaccessible.

For the remainder of this post, it is assumed that the underlying filtered probability space is complete. Whenever we refer to the compensator of a process X, it will be understood that X is a special semimartingale. Also, the jump ${\Delta X_t}$ of a process is defined to be zero at time ${t=\infty}$ .

Lemma 2 Let A be the compensator of a process X. Then, for a stopping time ${\tau}$ ,

${\Delta A_\tau=0}$ if ${\tau}$ is totally inaccessible.

${\Delta A_\tau={\mathbb E}\left[\Delta X_\tau\vert\mathcal{F}_{\tau-}\right]}$ if ${\tau}$ is predictable.

Continue reading “Compensators” →

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