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Financial Asset Pricing Theory$
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Claus Munk

Print publication date: 2013

Print ISBN-13: 9780199585496

Published to Oxford Scholarship Online: May 2013

DOI: 10.1093/acprof:oso/9780199585496.001.0001

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Uncertainty, Information, and Stochastic Processes

Uncertainty, Information, and Stochastic Processes

(p.24) 2 Uncertainty, Information, and Stochastic Processes
Financial Asset Pricing Theory

Claus Munk

Oxford University Press

Uncertainty is a key component of financial markets and thus of any asset pricing theory. This chapter provides the tools from probability theory that are being used in the asset pricing models covered in the remaining part of the book. The mathematical representation of uncertainty and information flow is explained. Stochastic processes are introduced with numerous examples both in discrete time and in continuous time. The important Ito’s Lemma is presented and illustrated by examples. The simultaneous handling of multiple stochastic processes is also discussed. The chapter is accessible with only little prior exposure to probability theory and continuous-time finance models.

Keywords:   Uncertainty, information flow, stochastic processes, standard Brownian motion, geometric Brownian motion, diffusion, Ito’s Lemma, correlated stochastic processes

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