Conditional Correlation for Stochastic Processes

analysisconditional-expectationmartingalesprobability

Any help with the following problem will be greatly appreciated.

Two stochastic processes $X_t$ and $Y_t$ are called conditionally uncorrelated given $\mathcal F_t$, if $$E[(X_t – X_s)(Y_t – Y_s)|\mathcal F_s] = 0 \quad \forall\, 0 \leq s < t < \infty $$

Let $X_t$ and $Y_t$ be martingale processes. Show that the processes $Z_t = X_tY_t$ is a martingale if and only if $X_t$ and $Y_t$ are conditionally uncorrelated. Assume that $X_t$, $Y_t$ and $Z_t$ are integrable.

Note: Apparently there is an identity $$E[(X_t – X_s)(Y_t – Y_s)|
\mathcal F_s] = E[X_tY_t – X_sY_s|\mathcal F_s]$$

however I am unsure how to use that in the above proof.

Thank you

Best Answer

First of all, we notice that \begin{align} E[(X_t - X_s)(Y_t - Y_s)| \mathcal F_s] &= E[X_tY_t - X_tY_s -X_sY_t +\underbrace{X_sY_s}_{\mathcal{F}_s-\text{mesurable}}|\mathcal F_s]\\ &= E[X_tY_t|\mathcal F_s] - Y_sE[X_t|\mathcal F_s] - X_sE[Y_t|\mathcal F_s] + X_sY_s \\ &= E[X_tY_t|\mathcal F_s] - Y_sX_s - X_sY_s + X_sY_s \\ &=E[X_tY_t-X_sY_s|\mathcal F_s]\tag{1} \end{align} The third equality comes from the fact that $X$ and $Y$ are martingales.

Let's do the $\Rightarrow$ first: Assume that $\lbrace{Z_t\rbrace}_{t\geq0}$ is a martingale. We have: for $s \leq t$ \begin{align} E[(X_t - X_s)(Y_t - Y_s)| \mathcal F_s] &= E[X_tY_t - X_sY_s|\mathcal F_s]\\ &= E[X_tY_t |\mathcal F_s]- X_sY_s \\ &= X_sY_s- X_sY_s = 0 \end{align} The last equality follows from the martingale property.

Now the $\Leftarrow$. We assume that $E[(X_t - X_s)(Y_t - Y_s)| \mathcal F_s] =0$. Using $(1)$, we have : \begin{align} &E[X_tY_t - X_sY_s|\mathcal F_s] =0\\ &\Rightarrow\quad E[X_tY_t|\mathcal F_s] = X_sY_s \end{align} Plus, we know that $Z\in L_1$. Therefore, we can conclude that $Z$ is a martingale.

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