gbm

Create GBM model

Synopsis

GBM = gbm(Return, Sigma)

GBM = gbm(Return, Sigma, 'Name1', Value1, 'Name2', Value2, ...)

Class

GBM

Description

This function creates and displays geometric Brownian motion (GBM) models, which derive from the CEV (constant elasticity of variance) class. Use GBM models to simulate sample paths of NVARS state variables driven by NBROWNS Brownian motion sources of risk over NPERIODS consecutive observation periods, approximating continuous-time GBM stochastic processes.

This function allows simulation of vector-valued GBM processes of the form:

dXt=μ(t)Xtdt+D(t,Xt)V(t)dWt(18-6)

where:

  • Xt is an NVARS-by-1 state vector of process variables.

  • μ is an NVARS-by-NVARS generalized expected instantaneous rate of return matrix.

  • D is an NVARS-by-NVARS diagonal matrix, where each element along the main diagonal is the corresponding element of the state vector Xt.

  • V is an NVARS-by-NBROWNS instantaneous volatility rate matrix.

  • dWt is an NBROWNS-by-1 Brownian motion vector.

Input Arguments

Specify required input parameters as one of the following types:

  • A MATLAB® array. Specifying an array indicates a static (non-time-varying) parametric specification. This array fully captures all implementation details, which are clearly associated with a parametric form.

  • A MATLAB function. Specifying a function provides indirect support for virtually any static, dynamic, linear, or nonlinear model. This parameter is supported via an interface, because all implementation details are hidden and fully encapsulated by the function.

    Note:   You can specify combinations of array and function input parameters as needed.

    Moreover, a parameter is identified as a deterministic function of time if the function accepts a scalar time t as its only input argument. Otherwise, a parameter is assumed to be a function of time t and state X(t) and is invoked with both input arguments.

The required input parameters are:

ReturnReturn represents the parameter μ. If you specify Return as an array and it must be an NVARS-by-NVARS matrix representing the expected (mean) instantaneous rate of return. As a deterministic function of time, when Return is called with a real-valued scalar time t as its only input, Return must produce an NVARS-by-NVARS matrix. If you specify Return as a function of time and state, it must return an NVARS-by-NVARS matrix when invoked with two inputs:
  • A real-valued scalar observation time t.

  • An NVARS-by-1 state vector Xt.

SigmaSigma represents the parameter V. If you specify Sigma as an array, it must be an NVARS-by-NBROWNS matrix of instantaneous volatility rates or as a deterministic function of time. In this case, each row of Sigma corresponds to a particular state variable. Each column corresponds to a particular Brownian source of uncertainty, and associates the magnitude of the exposure of state variables with sources of uncertainty. As a deterministic function of time, when Sigma is called with a real-valued scalar time t as its only input, Sigma must produce an NVARS-by-NBROWNS matrix. If you specify Sigma as a function of time and state, it must return an NVARS-by-NBROWNS matrix of volatility rates when invoked with two inputs:
  • A real-valued scalar observation time t.

  • An NVARS-by-1 state vector Xt.

Although the gbm function enforces no restrictions on the sign of Sigma volatilities, they are usually specified as positive values.

Optional Input Arguments

Specify optional input arguments as variable-length lists of matching parameter name/value pairs: 'Name1', Value1, 'Name2', Value2, ... and so on. The following rules apply when specifying parameter-name pairs:

  • Specify the parameter name as a character string, followed by its corresponding parameter value.

  • You can specify parameter name/value pairs in any order.

  • Parameter names are case insensitive.

  • You can specify unambiguous partial string matches.

Valid parameter names are:

StartTimeScalar starting time of the first observation, applied to all state variables. If you do not specify a value for StartTime, the default is 0.
StartStateScalar, NVARS-by-1 column vector, or NVARS-by-NTRIALS matrix of initial values of the state variables.

If StartState is a scalar, gbm applies the same initial value to all state variables on all trials.

If StartState is a column vector, gbm applies a unique initial value to each state variable on all trials.

If StartState is a matrix, gbm applies a unique initial value to each state variable on each trial.

If you do not specify a value for StartState, all variables start at 1.

CorrelationCorrelation between Gaussian random variates drawn to generate the Brownian motion vector (Wiener processes). Specify Correlation as an NBROWNS-by-NBROWNS positive semidefinite matrix, or as a deterministic function C(t) that accepts the current time t and returns an NBROWNS-by-NBROWNS positive semidefinite correlation matrix.

A Correlation matrix represents a static condition.

As a deterministic function of time, Correlation allows you to specify a dynamic correlation structure.

If you do not specify a value for Correlation, the default is an NBROWNS-by-NBROWNS identity matrix representing independent Gaussian processes.

SimulationA user-defined simulation function or SDE simulation method. If you do not specify a value for Simulation, the default method is simulation by Euler approximation (simByEuler).

Output Arguments

GBMGeometric Brownian motion model with the following displayed parameters:
  • StartTime: Initial observation time

  • StartState: Initial state at StartTime

  • Correlation: Access function for the Correlation input, callable as a function of time

  • Drift: Composite drift-rate function, callable as a function of time and state

  • Diffusion: Composite diffusion-rate function, callable as a function of time and state

  • Simulation: A simulation function or method

  • Return: Access function for the input argument Return, callable as a function of time and state

  • Sigma: Access function for the input argument Sigma, callable as a function of time and state

More About

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Algorithms

When you specify the required input parameters as arrays, they are associated with a specific parametric form. By contrast, when you specify either required input parameter as a function, you can customize virtually any specification.

Accessing the output parameters with no inputs simply returns the original input specification. Thus, when you invoke these parameters with no inputs, they behave like simple properties and allow you to test the data type (double vs. function, or equivalently, static vs. dynamic) of the original input specification. This is useful for validating and designing methods.

When you invoke these parameters with inputs, they behave like functions, giving the impression of dynamic behavior. The parameters accept the observation time t and a state vector Xt, and return an array of appropriate dimension. Even if you originally specified an input as an array, gbm treats it as a static function of time and state, thereby guaranteeing that all parameters are accessible by the same interface.

References

Ait-Sahalia, Y., "Testing Continuous-Time Models of the Spot Interest Rate," The Review of Financial Studies, Spring 1996, Vol. 9, No. 2, pp. 385–426.

Ait-Sahalia, Y., "Transition Densities for Interest Rate and Other Nonlinear Diffusions," The Journal of Finance, Vol. 54, No. 4, August 1999.

Glasserman, P., Monte Carlo Methods in Financial Engineering, New York: Springer-Verlag, 2004.

Hull, J. C., Options, Futures, and Other Derivatives, 5th ed. Englewood Cliffs, NJ: Prentice Hall, 2002.

Johnson, N. L., S. Kotz, and N. Balakrishnan, Continuous Univariate Distributions, Vol. 2, 2nd ed. New York: John Wiley & Sons, 1995.

Shreve, S. E., Stochastic Calculus for Finance II: Continuous-Time Models, New York: Springer-Verlag, 2004.

See Also

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