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RANDOM WALKS

A random walk is a simple discrete stochastic process formed by successive summation of independent and identically distributed random variables. Random walks are one of the most widely studied topics in probability theory and have important applications in finance. In this chapter, we present random walks and relevant results.

26.1 Basic Concepts and Facts

Definition 26.1 (Random Walk). A random walk {Sn : n ≥ 0} starting at x is a stochastic process defined as where x R and Zi’s are independent and identically distributed random variables.

Definition 26.2 (Simple Random Walk). Let {Sn : n ≥ 0} be a random walk as defined in Definition 26.1. It is called a simple random walk if for every n ≥ 1, where p (0, 1).

26.2 Problems

26.1. Let {Sn : n ≥ 0} be a random walk as defined in Definition 26.1. Let μ = E[Z1] and . Suppose that |μ| < ∞ and σ < ∞. Show that

(a) {Sn − μn : n ≥ 0} is a martingale.
(b) {(Sn − μn)2 − σ2n : n ≥ 0} is a martingale.
(c) For any u R

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