Stochastic modeling of stock price process induced from the conjugate heat equation

Seong-Hun Paeng

Physica A: Statistical Mechanics and its Applications, 2015, vol. 419, issue C, 385-394

Abstract: Currency can be considered as a ruler for values of commodities. Then the price is the measured value by the ruler. We can suppose that inflation and variation of exchange rate are caused by variation of the scale of the ruler. In geometry, variation of the scale means that the metric is time-dependent. The conjugate heat equation is the modified heat equation which satisfies the heat conservation law for the time-dependent metric space. We propose a new model of stock prices by using the stochastic process whose transition probability is determined by the kernel of the conjugate heat equation. Our model of stock prices shows how the volatility term is affected by inflation and exchange rate. This model modifies the Black–Scholes equation in light of inflation and exchange rate.

Keywords: Time-dependent metric; Conjugate heat equation; Brownian motion; The Black–Scholes equation (search for similar items in EconPapers)
Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:419:y:2015:i:c:p:385-394

DOI: 10.1016/j.physa.2014.09.021

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