Novikov's condition

In probability theory, Novikov's condition is the sufficient condition for a stochastic process which takes the form of the Radon-Nikodym derivative in Girsanov's theorem to be a martingale. If satisfied together with other conditions, Girsanov's theorem may be applied to a Brownian motion stochastic process to change from the original measure to the new measure defined by the Radon-Nikodym derivative.

This condition was suggested and proved by Alexander Novikov. There are other results which may be used to show that the Radon-Nikodym derivative is a martingale, such as the more general criterion Kazamaki's condition, however Novikov's condition is the most well-known result.

Assume that  (X_t)_{0\leq t\leq T} is a real valued adapted process on the probability space  \left (\Omega, (\mathcal{F}_t), \mathbb{P}\right) and (W_t)_{0\leq t\leq T} is an adapted Brownian motion:[1]:334

If the condition

   
\mathbb{E}\left[e^{\frac12\int_0^T|X|_t^2\,dt}   \right]<\infty

is fulfilled then the process


  \ \mathcal{E}\left( \int_0^t X_s \; dW_s \right) \ = e^{\int_0^t X_s\, dW_s  -\frac{1}{2}\int_0^t X_s^2\, ds},\quad 0\leq t\leq T

is a martingale under the probability measure \mathbb{P} and the filtration \mathcal{F}. Here \mathcal{E} denotes the Doléans-Dade exponential.

References

  1. Pascucci, Andrea (2011) PDE and Martingale Methods in Option Pricing. Berlin: Springer-Verlag

Comments on Girsanov's Theorem by H. E. Krogstad, IMF 2003

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