$e^{X_t}$ is martingale using Ito’s Formula

local-martingalesmartingalesstochastic-calculusstochastic-differential-equations

$B_t$ is the Brownian process. How to prove that $ Y_t=e^{X_t}$ is a martingale using Itô's formula?
Here we have, for $f$ deterministic $$X_t = \int_0^t f(s)dB_s-\frac{1}{2}\int_0^t f^2(s)ds $$ and $E(e^{2X_t})<\infty$.

Attempt: Since $E(Y_t)=E(e^{2X_t})<\infty$ the $Y_t$ is square integrable the Ito can be applied. Taking $g(x) = e^x$ then $$g(X_t)=Y_t=1+\int_0^t e^{X_t}dX_t + \frac{1}{2}\int_0^t e^{X_s}ds$$
My idea is that if I can show that the last term is 0 then as $\int g(B_s) d B_s$ is martingale we are done.
$$\frac{1}{2}\int_0^t e^{X_s}ds=\frac{1}{2}\int_0^t e^{\int_0^s f(u)dB_u-\frac{1}{2}\int_0^s f^2(u)du}ds = ?? $$

Best Answer

When working with these computations, it's usually easier to write the SDE in differential form. We know that the dynamics of $X_t$ are given by $$X_t = f(t) dB_t - \frac{1}{2}f^2(t) dt$$

Applying Itô's lemma with $g(x) = e^x$, we get: $$\begin{align*} dY_t &= \frac{1}{2} e^{X_t}(dX_t)^2 + e^{X_t} dX_t \\ &= \frac{1}{2}e^{X_t} f^2(t)dt + e^{X_t}f(t)dB_t - \frac{1}{2} e^{X_t} f^2(t)dt \\ &= e^{X_t}f(t) dB_t \end{align*}$$

Since $Y_t$ is driftless, it is a local martingale. But then, if $f$ is reasonable, we actually have that $E\left( \int_0^t e^{2X_s} f^2(s)ds \right) < \infty$, which lets you conclude that $Y_t$ is a martingale.

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