Stochastic Taylor Expansions for the Expectation of Functionals of Diffusion Processes

Abstract

Stochastic Taylor expansions of the expectation of functionals applied to diffusion processes which are solutions of stochastic differential equation systems are introduced. Taylor formulas w.r.t. increments of the time are presented for both, Itô and Stratonovich stochastic differential equation systems with multi-dimensional Wiener processes. Due to the very complex formulas arising for higher order expansions, an advantageous graphical representation by coloured trees is developed. The convergence of truncated formulas is analyzed and estimates for the truncation error are calculated. Finally, the stochastic Taylor formulas based on coloured trees turn out to be a generalization of the deterministic Taylor formulas using plain trees as recommended by Butcher for the solutions of ordinary differential equations.

Key Words:

• Stochastic Taylor expansion
• Stochastic differential equation
• Diffusion process

MSC 2000:

• 60H10
• 65C30
• 60J60
• 41A58

Notes

^a L ⁰ is also called the generator of the solution X (see, e.g., Refs.5 9 12).