Stochastic process

temperature, and random movement such as Brownian

motion or random walks. Examples of random elds in-
clude static images, random terrain (landscapes), wind
waves or composition variations of a heterogeneous ma-
terial.
A generalization, the random eld, is dened by letting
the variables parameters be members of a topological
space instead of limited to real values representing time.

1 Formal denition and basic

Stock market uctuations have been modeled by stochastic pro-
cesses. properties

In probability theory, a stochastic (/stokstk/) pro- 1.1 Denition

cess, or often random process, is a collection of random
variables, representing the evolution of some system of Given a probability space (, F, P ) and a measurable
random values over time. This is the probabilistic coun- space (S, ) , an S-valued stochastic process is a col-
terpart to a deterministic process (or deterministic sys- lection of S-valued random variables on , indexed by a
tem). Instead of describing a process which can only totally ordered set T (time). That is, a stochastic pro-
evolve in one way (as in the case, for example, of solu- cess X is a collection
tions of an ordinary dierential equation), in a stochas-
tic or random process there is some indeterminacy: even
if the initial condition (or starting point) is known, there {Xt : t T }
are several (often innitely many) directions in which the
process may evolve. where each Xt is an S-valued random variable on . The
In the simple case of discrete time, as opposed to space S is then called the state space of the process.
continuous time, a stochastic process involves a sequence
of random variables and the time series associated with
1.2 Finite-dimensional distributions
these random variables (for example, see Markov chain,
also known as discrete-time Markov chain). One ap-
Let X be an S-valued stochastic process. For every nite
proach to stochastic processes treats them as functions
sequence T = (t1 , . . . , tk ) T k , the k-tuple XT =
of one or several deterministic arguments (inputs; in
(Xt1 , Xt2 , . . . , Xtk ) is a random variable taking values
most cases this will be the time parameter) whose values
in S k . The distribution PT () = P(XT1 ()) of this
(outputs) are random variables: non-deterministic (sin-
random variable is a probability measure on S k . This is
gle) quantities which have certain probability distribu-
called a nite-dimensional distribution of X.
tions. Random variables corresponding to various times
(or points, in the case of random elds) may be com- Under suitable topological restrictions, a suitably consis-
pletely dierent. The main requirement is that these dif- tent collection of nite-dimensional distributions can be
ferent random quantities all take values in the same space used to dene a stochastic process (see Kolmogorov ex-
(the codomain of the function). Although the random tension in the Construction section).
values of a stochastic process at dierent times may be
independent random variables, in most commonly con-
sidered situations they exhibit complicated statistical cor- 2 History of stochastic processes
relations.
Familiar examples of processes modeled as stochastic Stochastic processes were rst studied rigorously in the
time series include stock market and exchange rate uc- late 19th century to aid in understanding nancial mar-
tuations, signals such as speech, audio and video, medical kets and Brownian motion. The rst person to describe
data such as a patients EKG, EEG, blood pressure or the mathematics behind Brownian motion was Thorvald

1
2 3 CONSTRUCTION
N. Thiele in a paper on the method of least squares pub-
lished in 1880. This was followed independently by Louis
Bachelier in 1900 in his PhD thesis The theory of specu-
lation, in which he presented a stochastic analysis of the
stock and option markets. Albert Einstein (in one of his
1905 papers) and Marian Smoluchowski (1906) brought
the solution of the problem to the attention of physicists,
and presented it as a way to indirectly conrm the exis-
tence of atoms and molecules. Their equations describ-
ing Brownian motion were subsequently veried by the
experimental work of Jean Baptiste Perrin in 1908.
An excerpt from Einsteins paper describes the funda-
mentals of a stochastic model: Recall that in the Kolmogorov axiomatization,
measurable sets are the sets which have a probabil-
It must clearly be assumed that each indi- ity or, in other words, the sets corresponding to yes/no
vidual particle executes a motion which is in- questions that have a probabilistic answer.
dependent of the motions of all other particles;
it will also be considered that the movements
of one and the same particle in dierent time
intervals are independent processes, as long as
these time intervals are not chosen too small.
We introduce a time interval into consider-
ation, which is very small compared to the
observable time intervals, but nevertheless so
large that in two successive time intervals ,
the motions executed by the particle can be
thought of as events which are independent of
each other.
3 Construction
In the ordinary axiomatization of probability theory by
means of measure theory, the problem is to construct a
sigma-algebra of measurable subsets of the space of all
functions, and then put a nite measure on it. For this pur-
pose one traditionally uses a method called Kolmogorov
extension.[1]
3.1 Kolmogorov extension
The Kolmogorov extension proceeds along the following
lines: assuming that a probability measure on the space
of all functions f : X Y exists, then it can be
used to specify the joint probability distribution of nite-
dimensional random variables f (x1 ), . . . , f (xn ) . Now,
from this n-dimensional probability distribution we can
deduce an (n 1)-dimensional marginal probability dis-
tribution for f (x1 ), . . . , f (xn1 ) . Note that the obvious
compatibility condition, namely, that this marginal prob-
ability distribution be in the same class as the one derived
from the full-blown stochastic process, is not a require-
ment. Such a condition only holds, for example, if the
stochastic process is a Wiener process (in which case the
marginals are all gaussian distributions of the exponen-
tial class) but not in general for all stochastic processes.
When this condition is expressed in terms of probability
densities, the result is called the ChapmanKolmogorov
equation.
The Kolmogorov extension theorem guarantees the ex-
istence of a stochastic process with a given family of
nite-dimensional probability distributions satisfying the
ChapmanKolmogorov compatibility condition.
3.2 Separability, or what the Kolmogorov
extension does not provide
The Kolmogorov extension starts by declaring to be mea-
surable all sets of functions where nitely many coordi-
nates [f (x1 ), . . . , f (xn )] are restricted to lie in measur-
able subsets of Yn . In other words, if a yes/no question
about f can be answered by looking at the values of at
most nitely many coordinates, then it has a probabilistic
answer.
In measure theory, if we have a countably innite col-
lection of measurable sets, then the union and intersec-
tion of all of them is a measurable set. For our purposes,
this means that yes/no questions that depend on countably
many coordinates have a probabilistic answer.
The good news is that the Kolmogorov extension makes it
possible to construct stochastic processes with fairly arbi-
trary nite-dimensional distributions. Also, every ques-
tion that one could ask about a sequence has a probabilis-
tic answer when asked of a random sequence. The bad
news is that certain questions about functions on a con-
tinuous domain don't have a probabilistic answer. One
might hope that the questions that depend on uncountably
many values of a function be of little interest, but the re-
ally bad news is that virtually all concepts of calculus are
of this sort. For example:
1. boundedness
2. continuity
3. dierentiability
all require knowledge of uncountably many values of the
function.
One solution to this problem is to require that the stochas-
tic process be separable. In other words, that there be
some countable set of coordinates {f (xi )} whose values
determine the whole random function f.
The Kolmogorov continuity theorem guarantees that pro-
cesses that satisfy certain constraints on the moments of
their increments have continuous modications and are
therefore separable.
5.3 Discrete time and continuous state space 3

4 Filtrations together, is treated as being continuous and since the par-

ticle is constrained to the surface of the liquid by sur-
Given a probability space (, F, P ) , a ltration is a face tension, is at each point in time a vector parallel to
weakly increasing collection of sigma-algebras on , the surface. Thus, the random force is described by a
{Ft , t T } , indexed by some totally ordered set T , two-component stochastic process; two real-valued ran-
and bounded above by F , i.e. for s,t T with s < t, dom variables are associated to each point in the index
set, time, (note that since the liquid is viewed as being
homogeneous the force is independent of the spatial co-
ordinates) with the domain of the two random variables
Fs Ft F being R, giving the x and y components of the force.
A treatment of Brownian motion generally also includes
A stochastic process X on the same time set T is said to
the eect of viscosity, resulting in an equation of motion
be adapted to the ltration if, for every t T , Xt is Ft
known as the Langevin equation.[4]
-measurable.[2]

4.1 Natural ltration 5.3 Discrete time and continuous state

space
Given a stochastic process X = {Xt : t T } , the
natural ltration for (or induced by) this process is the If the index set of the process is N (the natural numbers),
ltration where Ft is generated by all values of Xs up to and the range is R (the real numbers), there are some
time s = t, i.e. Ft = ({Xs1 (A) : s t, A }) . natural questions to ask about the sample sequences of a
A stochastic process is always adapted to its natural l- process {Xi}i N, where a sample sequence is {Xi()}i
tration. N.

1. What is the probability that each sample sequence is

5 Classication bounded?

Stochastic processes can be classied according to the 2. What is the probability that each sample sequence is
cardinality of its index set (usually interpreted as time) monotonic?
and state space.
3. What is the probability that each sample sequence
has a limit as the index approaches ?
5.1 Discrete time and discrete state space
4. What is the probability that the series obtained from
If both t and Xt belong to N , the set of natural numbers, a sample sequence from f (i) converges?
then we have models which lead to Markov chains. For
example: 5. What is the probability distribution of the sum?
(a) If Xt means the bit (0 or 1) in position t of a sequence
of transmitted bits, then Xt can be modelled as a Markov Main applications of discrete time continuous state
chain with two states. This leads to the error-correcting stochastic models include Markov chain Monte Carlo
Viterbi algorithm in data transmission. (MCMC) and the analysis of Time Series.
(b) If Xt represents the combined genotype of a breeding
couple in the t th generation in an inbreeding model, it can
be shown that the proportion of heterozygous individuals 5.4 Continuous time and discrete state
in the population approaches zero as t goes to .[3] space

Similarly, if the index space I is a nite or innite interval,

5.2 Continuous time and continuous state we can ask about the sample paths {Xt()}t I
space

The paradigm of continuous stochastic process is that of 1. What is the probability that it is
the Wiener process. In its original form the problem was bounded/integrable...?
concerned with a particle oating on a liquid surface, re-
ceiving kicks from the molecules of the liquid. The par- 2. What is the probability that it has a limit at
ticle is then viewed as being subject to a random force
which, since the molecules are very small and very close 3. What is the probability distribution of the integral?
4 8 FURTHER READING

6 See also Boris Tsirelson. Lecture notes in Advanced proba-

bility theory".
List of stochastic processes topics
Doob, J. L. (1953). Stochastic Processes. Wiley.
Covariance function
Klebaner, Fima C. (2011). Introduction to Stochastic
Dynamics of Markovian particles Calculus With Applications. Imperial College Press.
ISBN 1-84816-831-4.
Entropy rate (for a stochastic process)
Bruce Hajek (July 2006). An Exploration of Ran-
Ergodic process dom Processes for Engineers.
Gillespie algorithm An 8 foot tall Probability Machine (named Sir
Francis) comparing stock market returns to the ran-
Interacting particle system
domness of the beans dropping through the quin-
Law (stochastic processes) cunx pattern. Index Funds Advisors.

Markov chain Popular Stochastic Processes used in Quantitative

Finance. sitmo.com.
Probabilistic cellular automaton
Interactive Web Application: Stochastic Processes
Random eld used in Quantitative Finance. TuringFinance.com.
Randomness Addressing Risk and Uncertainty.
Stationary process
Statistical model
Stochastic calculus
Stochastic control

7 References
[1] Karlin, Samuel & Taylor, Howard M. (1998). An Intro-
duction to Stochastic Modeling, Academic Press. ISBN 0-
12-684887-4.

[2] Durrett, Rick (2010). Probability: Theory and Examples

(Fourth ed.). Cambridge: Cambridge University Press.
ISBN 978-0-521-76539-8.

[3] Allen, Linda J. S., An Introduction to Stochastic Processes

with Applications to Biology, 2nd Edition, Chapman and
Hall, 2010, ISBN 1-4398-1882-7

[4] Gardiner, C. Handbook of Stochastic Methods: for

Physics, Chemistry and the Natural Sciences, 3rd ed.,
Springer, 2004, ISBN 3540208828

8 Further reading
Wio, S. Horacio, Deza, R. Roberto & Lopez, M.
Juan (2012). An Introduction to Stochastic Processes
and Nonequilibrium Statistical Physics. World Sci-
entic Publishing. ISBN 978-981-4374-78-1.
Papoulis, Athanasios & Pillai, S. Unnikr-
ishna (2001). Probability, Random Variables
and Stochastic Processes. McGraw-Hill Sci-
ence/Engineering/Math. ISBN 0-07-281725-9.
 5

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