Dynamic Markov bridges motivated by models of insider trading

Luciano Campi, Umut Cetin and Albina Danilova

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Given a Markovian Brownian martingale Z, we build a process X which is a martingale in its own filtration and satisfies X1=Z1. We call X a dynamic bridge, because its terminal value Z1 is not known in advance. We compute its semimartingale decomposition explicitly under both its own filtration View the MathML source and the filtration View the MathML source jointly generated by X and Z. Our construction is heavily based on parabolic partial differential equations and filtering techniques. As an application, we explicitly solve an equilibrium model with insider trading that can be viewed as a non-Gaussian generalization of the model of Back and Pedersen (1998) [3], where the insider’s additional information evolves over time.

JEL-codes: C1 F3 G3 (search for similar items in EconPapers)
Date: 2011-03
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Citations: View citations in EconPapers (20)

Published in Stochastic Processes and Their Applications, March, 2011, 121(3), pp. 534-567. ISSN: 0304-4149

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