Ensuring Finite Seconds Moments in SDE Solutions With Reference to the Libor Market Model
Document ID: 2006-311 (previously 2006/021)
Published on: 1st November 2006
Author: Rutang Thanawalla
This note reviews conditions under which Ito solutions exist and are unique for stochastic differential equations. The discussion is pertinent to models such as the Libor market model in which, at finer time steps and under the spot measure with proportional volatility, the drift of the stochastic differential equation being simulated grows at a nonlinear rate. In such cases, the variance of the variable modelled (forward rates in the LMM) can explode.
