Polynomial Diffusions and Applications in Finance

Abstract

This paper provides the mathematical foundation for polynomial diffusions. They play an important role in a growing range of applications in finance, including financial market models for interest rates, credit risk, stochastic volatility, commodities and electricity. Uniqueness of polynomial diffusions is established via moment determinacy in combination with pathwise uniqueness. Existence boils down to a stochastic invariance problem that we solve for semialgebraic state spaces. Examples include the unit ball, the product of the unit cube and nonnegative orthant, and the unit simplex.Comment: This article is forthcoming in Finance and Stochastic