JUMP PROCESSES

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Contents
1. Levy processes: denition and properties 1
1.1. Compound Poisson processes 3
1.2. Jump measure of compound Poisson process 4
1.3. Innite activity Levy processes 6
1.4. Pathwise properties of Levy processes 12
1.5. Distributional properties 15
1.6. Stable laws and processes 18
1.7. Levy processes as Markov processes 20
1.8. Levy processes and martingales 22
1. Levy processes: definition and properties
1.0.1. From random walks to Levy processes.
Denition 1.1. Levy process A cadlag stochastic process (X
t
)
t0
on (, F, P)
with values in R
d
such that X
0
= 0 is called a Levy process if it posses the following
properties:
(1) Independent increments: for every increasing sequence of time t
0
, . . . , t
n
,
the random variables X
t
0
, T
t
1
X
t
0
, . . . , X
t
n
X
t
n1
(2) Stationary increments: the law of X
t+h
X
t
doe snot depend on t.
(3) Stochastic continuity: > 0, lim
h0
P(X
t+h
X
t
| ) = 0.
The third condition does not mean that sample paths are continuous, it means
that for a given time t, the probability of seeing a jump at t is zero: discontinuities
occur at random times.
If we sample a Levy process at regular time intervals 0, , 2, . . . we obtain a
random walk: dening S
n
() = X
n
, we can write S
n
() =

k
= 0
n1
Y
k
where
Y
k
= X
(k+1)
X
k
are i.i.d. random variables whose distribution is the same as the distribution of
X

. Choosing n = t, we see that for any t > 0 and any n 1, X

t
= S
n
() can
be represented as a sum of n i.i.d random variables whose distribution is that of
1
2 TANKOV-CONT
X
t/n
: X
t
can be divided into n i.i.d parts. A distribution having this property is
said to be innitely divisible:
Denition 1.2. Innite divisibility A probability distribution F on R
d
is said to
be innitely divisible if for any integer n 2, there exists n i.i.d random variables
Y
1
, . . . , Y
n
such that Y
1
+ Y
2
+ + Y
n
has distribution F.
Since the distribution of i.i.d. sums is given by convolution of the distribution
of the summands, if we denote by the distribution of the Y
k
-s in the denition
above, then F = is the n-th convolution of . So an innitely
divisible distribution can also be dened as a distribution F for which the n-th
convolution root is still a probability distribution, for any n 2.
If X is a Levy process, for any t > 0 the distribution of X
t
is innitely divisible.
this puts a constraint on the possible choices of distributions of rX
t
: whereas the
increments of a discrete time random walk can have arbitrary distribution, the
distribution of increments of a Levy process has to be innitely divisible.
Examples of innitely divisible laws are: the Gaussian distribution
1
, the gamma
distribution, the Poisson distribution.
Given an innitely divisible distribution F, it is easy to see that for any n 1
by chopping it into n i.i.d. components we ca construct a random walk model on
a time grid with step size 1/n such that the law of the position at t = 1 is given by
F. In the limit, this procedure can be used to construct a continuous time Levy
process (X
t
)
t0
such that the law of X
1
if given by F:
Proposition 1.3. Innite divisibility and Levy processes Let X
t
)
t0
be a
Levy process. Then for every t, X
t
has a innitely divisible distribution. Con-
versely, if F is an innitely divisible distribution then there exists a Levy process
(X
t
) such that the distribution of X
1
is given by F.
Dene the characteristic function of X
t
:

t
(z) =
X
t
(z) = E[e
i
z.X
T
], z R
d
(1)
For t > s, by writing X
t
+ s = X
s
+ (X
t
+ s X
s
) and using the fact that
X
t+s
X
s
is independent of X
s
, we obtain that t
t
(z) is a multiplicative
function:

t+s
(z) =
X
t+s
(z) =
X
s
(z)
X
t+s
X
s
(z)
=
X
s
(z)
X
t
(z)
=
s

t
.
The stochastic continuity of t X
t
implies in particular that X
t
X
s
in distribu-
tion when s t. Therefore, from the fact that
X
n
(z)
X
(z),
X
s
(z)
X
t
(z)
1
If X sin N(,
2
) then one can write X =

k=0
n1
Y
k
where Y
k
are i.i.d.with law N(/n,
2
/n).
JUMP PROCESSES 3
when s t so t
t
(z) is a continuous function t. Together with the multiplica-
tive property
s+t
(z) =
s
(z)
t
(z) this implies that t
t
(z) is an exponential
function
Proposition 1.4. Characteristic function of a Levy process Let (X
t
)
t0
be
a Levy process on R
d
. There exists a continuous function : R
d
R called the
characteristic exponent of X, such that
E[e
iz.X
t
] = e
t(z)
, z R
d
(2)
Recalling the denition of the cumulant generating function of a random vari-
able, we see that is the cumulant generating function of X
1
: =
X
1
and that
the cumulant generating function of X
t
varies linearly in t :
X
t
= t
X
1
= t.
The law of X
t
is therefore determined by the knowledge of the law of X
1
: the only
degree of freedom we have in specifying a Levy process is to specify the distribution
of X
t
for a single time (say, t = 1).
1.1. Compound Poisson processes.
Denition 1.5. Compound Poisson process A compound Poisson process
with intensity > 0 and jump size distribution f is a stochastic process X
t
dened
as
X
t
=
N
t

i=1
Y
i
(3)
where jumps sizes Y
i
are i.i.d. with distribution f and (N
t
) is a Poisson process
with intensity , independent from (Y
i
)
i1
.
The following properties of a compound Poisson process are easily deducted
from the denition:
(1) The sample paths of X are cadlag piecewise constant functions.
(2) The jump times (T
i
)
i1
have the same law as the jump times of the Poisson
process N
t
: they can be expressed as partial sums of independent exponen-
tial random variables with parameter .
(3) The jump sizes (Y
i
)
i1
are independent and identically distributed with law
f.
The Poisson process itself can be seen as a compound Poisson process on R
such that Y = 1. Let R(n), n 0 be a random walk with step size distribution
f : R(n) =

n
i=0
y
i
. The compound Poisson process X
t
can be obtained by
changing the time R with an independent Poisson process N
t
: X
t
= R(N
t
). X
t
thus describes the position of a random walk after the random number of steps,
given by N
t
. This operation is similar to the subordination of Levy processes.
Proposition 1.6. (X
t
)
t0
is compound Poisson process if and only if it is a Levy
process and its sample paths are piecewise constant functions.
See Tankov and Cont (2004), pp.72 for a proof.
4 TANKOV-CONT
Proposition 1.7. Characteristic function of a compound Poisson pro-
cess Let (X
t
)
t0
be a compound Poisson process on R
d
. Its characteristic function
has the following representation:
E[e
iu.X
t
] = exp
_
t
_
R
d
(e
iu.x
1)f(dx)}, u R
d
_
, u R
d
(4)
where denotes the jump intensity and f the jump size distribution.
Comparing (4) with the characteristic function of a Poisson process E[e
iuN
t
] =
exp {t(e
iu
1)} , u R we see that a compound Poisson random variable can
be represented as a superposition of independent Poisson processes with dierent
jump sizes. The total intensity of Poisson processes with jump sizes in the interval
[x, x + dx] is determined by the density f(dx).
Proof. Conditioning the expectation on N
t
and denoting the characteristic function
of f by

f, we nd
E[exp(iu.X
t
)] = E[E[exp(iu.X
t
)]|N
t
] = E[(

f(u))
N
t
]
=

n=0
e
t
(t)
n
(

f(u))
n
n!
= exp{t(

f(u) 1}
= exp
_
t
_
R
d
(e
iu.x
1)f(dx).
_

For one-dimentional compound Poisson processes the characteristic function has

a simpler form:
E[exp{iuX
t
}] = exp
_
t
_

(e
iux
1)f(dx)
_
, u R.
Introducing a new measure v(A) = f(A), we can rewrite the formula (4) as:
E[exp(iu.X
t
)] = exp
_
t
_
R
d
(e
iu.x
1)v(dx)
_
, u R
d
(5)
1.2. Jump measure of compound Poisson process. We will use the notion of
random measure to study the behaviour of jumps of a compound Poisson process.
To every cadlag process and in particular to every compound Poisson process
(X
t
)
t0
on R
d
one can associate a random measure on R
d
[0, ] describing the
jumps of X: for measurable set B R
d
[0, [
J
X
(B) = #{t, X
t
X
t
) B} (6)
For every measurable set A R
d
, J
X
([t
1
, t
2
] A) counts the number of jumps of
X between t
1
and t
2
such that their jump sizes are in A. The following proposition
JUMP PROCESSES 5
shows that J
X
is a Poisson random measure (in the sense of proposition 2.18 TC
pp. 57.)
Proposition 1.8. Jump measure of a compound Poisson process Let
(X
t
)
t0
be a compound Poisson process with intensity and jump size distribu-
tion f. Its jump measure J
X
is a Poisson random measure on R
d
[0, [ with
intensity measure (dx dt) = v(dx)dt = f(dx)dt.
This represents an alternative interpretation of the Levy measure of a compound
Poisson process as the average number of jumps per unit of time.
Denition 1.9. Levy measure Let (X
t
)
t0
be a Levy process on R
d
. The measure
v on R
d
dened by:
v(A) = E[#{t [0, 1] : X
t
A}], A B(R
d
) (7)
is called a Levy measure of X : v(A) is the expected number, per unit time, of
jumps whose size belong to A.
Proof of Proposition 1.8, see Tankov and Cont (2004) pp. 76.
Proposition 1.8 implies that every compound Poisson process can be represented
in the following form:
X
t
=

s[0,t]
X
s
=
_
[0,t]R
d
xJx(ds dx) (8)
where J
X
is a Poisson random measure with intensity measure v(dx)dt. This is
a special case of the Levy-Ito decomposition for Levy processes. Here we have
rewritten the process X as the sum of its jumps. A compound Poisson process has
almost surely a nite number of jumps in the interval [0, t], the stochastic integral
appearing in (8) is a nite sum, so there are no convergence problems.
Lemma 1.10. Let M be a Poisson random measure with intensity measure and
let A be a measurable set much that 0 < (A) < . Then the following two
random measures on the subsets of A have the same distribution conditionally on
M(A):
(1) M|
A
, the restriction of M to A.
(2)

M
A
dened by

M
A
(B) = #{X
i
B} for all measurable subsets B of A,
where X
i
, i = 1, 2, . . . , M(A) are independent and distributed on A with the
law
(dx)
(A)
. In other words,

M
A
is the counting measure of M(A) independent
random points, identically distributed on A.
Proof see Tankov and Cont (2004) pp. 78.
As an application of Lemma 1.10, consider the following
Proposition 1.11. Exponential formula for Poisson random measures
Let M be a Poisson random measure with intensity measure . Then the following
6 TANKOV-CONT
formula holds for every measurable set B such that (B) < and for all functions
f such that
_
B
e
f(x)
(dx) < :
Eexp
__
B
f(x)M(dx)
_
= exp
__
B
(e
f(x)
1)(dx)
_
(9)
Proof. Condition the expectation on (B) and use Lemma 1.10.
We will see that to obtain this formula we do not need the assumption that both
(B) and
_
B
e
f(x)
(dx) be nite, it suce only to require
_
B
|e
f(x)
1|(dx) < .
Proposition 1.11 allows to establish a one-to-one correspondence between com-
pound Poisson processes and Poisson random measures with intensity measures of
the form v(dx)dt) with v nite. Indeed, let v be a nite measure on RD and let
M be a Poisson random measure on R
d
[0, [ with intensity measure v(dx)dt.
Then one can show using Proposition 1.11 that equation (8) denes a compound
Poisson process with Levy measure v.
1.3. Innite activity Levy processes. in the previous section, every piecewise
constant Levy process X
0
t
can be represents in the form (8) for some Poisson
random measure with intensity of the form v(dx)dt where v is a nite measure,
dened by
v(A) = E[#{t [0, 1] : X
0
t
= 0, X
0
t
A}], A B(R
d
). (10)
Given a Brownian motion with drift t + W
t
, independent from X
0
, the sum
X
t
= X
0
t
+ t + W
t
denes another Levy process, which can be decomposed as:
X
t
= t + W
t
+

s[0,t]
X
s
= t + W
t
+
_
[0,t]R
d
xJ
X
(ds dx),
where J
X
is a Poisson random measure on [0, [R
d
with intensity v(dx)dt.
Can every Levy process be represented in this form ? Given a Levy process X
t
,
can still dene its Levy measure v above. v(A) is still nite for any compact set
A such that 0 / A: if this is not true, the process would have an innite number
of jumps of nite size on [0, T], which contradicts the cadlag property.
So v denes a Radon measure on R
d
\{0}. But v is not necessarily a nite
measure: the above restriction still allows it to blow up at zero and X may have
an innite number of small jumps on [0, T]. In this case the sum of the jumps
becomes an innite series and tis convergence imposes some conditions on the
measure v under which we obtain a decomposition of X similar to the one above:
Proposition 1.12. Levy-Ito decomposition Let (X
t
)
t0
be a Levy process on
R
d
and v its Levy measure, given by Denition 1.9
(1) v is a Radon measure on R
d
\{0} and veries:
_
|x|1
|x|
2
v(dx) <
_
|x|1
v(dx) <
JUMP PROCESSES 7
(2) The jump measure of X, denoted bby J
X
, is a Poisson random measure on
[0, [R
d
with intensity measure v(dx)dt.
(3) There exist a vector and a d-dimensional Brownian motion
2
(B
t
)
t0
with
covariance matrix A such that
X
t
= t + B
t
+ X
l
T
+ lim
0

t
, where
X
l
t
=
_
|x|1,s[0,t]
xJ
X
(ds dx) and

t
=
_
|x|<1,s[0,t[
x{J
X
(ds dx) v(dx)ds}
=
_
|x|<1,s[0,t[
x

J
X
(ds dx)
(11)
The terms in X
t
= t +B
t
+X
l
T
+lim
0

t
are independent and the conver-
gence in the last term is almost sure and uniform in t on [0, T].
The Levy-Ito decomposition entails that for every Levy process there exist a
vector , a positive denite matrix A and a positive measure v that uniquely
determine its distribution. the triplet (A, v, ) is called characteristic triplet or
Levy triplet of the process X
t
.
Given the importance of this result, let us comment a bit on the meaning of the
terms in
X
t
= t + B
t
+ X
l
T
+ lim
0

t
First t + B
t
is a continuos Gaussian Levy process and every Gaussian Levy
process is continuous and ca be written in this form and can be described by two
parameters: the drift and the covariance matrix of Brownian motion, denoted
by A.
The other two terms are discontinuous processes incorporating jumps of X
t
and
are described by the Levy measure v. The condition
_
|y|1
v(dy) < means that
X has a nite number of jumps with absolute value larger than 1. So the sum
X
l
t
=
|X
s
|1

0st
X
s
contains almost surely a nite number of terms and X
l
t
is a compound Poisson
process. There is nothing special bout the threshold X = 1: for any > 0 the
8 TANKOV-CONT
sum of jumps with amplitude between and 1:
X

t
=
1>|X
s
|

ost
X
S
=
_
|x|<1,s[0,t]
xJ
X
(dsdx) (12)
is again a well dened compound Poisson process. Contrary to the compound
Poisson case, v can gave a singularity zero: there can be innitely many small
jumps and their sum does not necessarily converge. This prevents us from making
go to 0 directly in expression (12). In order to obtain convergence we have
to center the remainder term i.e. replace the jump integral by its compensated
version (dened in 2.6.2)

t
=
_
||x<1,s[0,t]
x

J
X
(ds dx) (13)
which (as in proposition 2.16) is a martingale. While X

can be interpreted as an
innite superposition of independent Poisson processes,

X

t
should be seen as an
innite superposition of independent compensated, i.e. centred Poisson processes
to which a central-limit type argument can now be applied to show convergence.
1.3.1. Implications. An important implication is that the Levy-Ito decomposition
is that every Levy process is a combination of a Brownian motion with drift and
a possibly innite sum of independent compound Poisson processes. This also
mean that every Levy process can be approximated with arbitrary precision by a
diusion process, that is the sum of Brownian motion with drift and a compound
Poisson process, a point which is useful both in theory and in practice.
Proof. of the Levy-Ito decomposition (outline) We construct a Poisson ran-
dom measure J
X
on [0, t] R
d
from the jumps of (X
t
). Since (X
t
) is cadlag, for any
positive the set {t : |X
t
X

| } is nite and the Poisson random measure (of

any closed set non containing 0) can be constructed using 1.8.
The intensity measure J
X
is homogeneous and equal to v(dx)dt. Throughout
the rest of the proof we can suppose without loss of generality that all jumps of
(X
t
) are smaller that 1 in absolute value.
Lemma 1.13. Let (X
T
, Y
T
) be a Levy process. If (Y
t
) is compound Poisson and
(X
t
) and (Y
t
) never jump together, then they are independent.
For a proof see Kallenberg, Lemma 13.6.
This lemma together with the exponential formula (6) allows to prove that the
Levy measure v satises the integrability condition
_
(|x|
2
1)v(dx) < (14)
JUMP PROCESSES 9
Since the Levy measure of any closed set not containing zero is nite, it is
sucient to prove that for some > 0,
_
|x|
|X|
2
v(dx) < .
Let X

t
be as above in (13) and let R

t
= X
t
X

t
. Then (X

t
, R

t
) is a Levy process
because (X
t
) is. Clearly for some u and some t we have |E exp{iuX
t
}| > 0. Let
us x this u and this t. Since Lemma 1.13, (X

t
) and (R

t
) are independent,
E exp{iuX
t
} = E exp{iuR

t
}E exp{iuX

t
},
and this means that |E exp{iuX

t
}| is bounded from below by a positive number
which does not depend on . By the exponential formula (Proposition 1.11) this
is equivalent to

exp
_
t
_
|x|
(e
iux
1)
_
v(dx)

C > 0,
which implies that
_
|x|
(1 cos(ux))v(dx)

C < .
Making tend to zero, we obtain (14).
Now we can use it to show the convergence of

X

t
. Consider a sequence {
n
} 0
and let Y
n
=

X

n+1
t


X

n
t
. All the variables Y
i
have zero mean and (14) entails
that

V arY
i
< . Hence, by Kolmogorovs three series Theorem (Kallenberg,
Lemma 3.15), one can show that the convergence is uniform in t.
To complete the proof, consider the process X
c
t
= X
t
lim

X

t
. It is a Levy
process which is independent from lim

X

t
by Lemma 1.13. It is continuous because

t
converges uniformly in t and therefore one can interchange the limits. Finally,
the Feller-Levy central limit Theorem (Kallenberg, Theorem 4.15) implies that it
is also Gaussian.
Our knowledge of the structure of paths of a Levy process allows to obtain al-
most without additional work the second fundamental result of the theory: the
expression of the characteristic function of a Levy process is terms of its charac-
teristic triplet (A, v, ).
Theorem 1.14. Levy-Khinchin representation
Let (X
t
)
t0
be a Levy process on R
d
with characteristic triplet (A, v, ). Then
E[e
iz.X
t
] = e
t(z)
, z R
d
(15)
with
(z) =
1
2
z Az + i.z +
_
R
d
(e
iz.x
1 iz.x1
|x|1
)v(dx).
10 TANKOV-CONT
For real-valued Levy processes, the formula 15 takes the form
E[e
izX
t
] = e
t(z)
, z Z
with
(z) =
1
2
Az
2
+ iz +
_

(e
iux
1 izx1
|x|1
)v(dx)
An equivalent version of the Levy-Khinchin representation may be obtained by
truncating the jumps larger than an arbitrary number :
(z) =
1
2
z Az + i

.z +
_
R
d
(e
iz.x
1 iz x1
|x|
)v(dx),
where

= +
_
R
d
x(1
|x|
1
|x|1
)v(dx).
More generally, for every bounded measurable function g : R
d
R satisfying
g(x) = 1 + o(|x|) as x 0 and g(x) = O(1/|x|) as x one can write:
(z) =
1
2
z az + i
g
.z +
_
R
d
(e
iz.x
1 iz.xg(x))v(dx).
Such a function g is called the truncation function and the characteristic triplet
(A, v,
g
) is called the characteristic triplet of X with respect to the truncation
function g. Dierent choices of g do not aect A and v which are intrinsic param-
eters of the Levy process, but depends on the choice of truncation function so
one should avoid calling it the drift of the process. Various version for g exists.
Paul Levy used the truncation function g(x) =
1
1+|x|
2
while most recent texts use
g(x) = 1
|x|1
. In the sequel, when we refer to the Levy triplet of a Levy process
we implicitly refer to the truncation function g(x) = 1
|x|1
.
If the Levy meaure satises the additional condition
_
|x|1
|x|v(dx) < there
is no need to truncate large jumps and one can use the simpler form
(z) =
1
2
z.Az + i
c
.z +
_
R
d
(e
iz.x
1 iz.x)v(dx).
In this case it can be shown that E[X
t
] =
c
t and
c
is called the center of process
(X
t
). It is linked to by the relation

c
= +
_
|x|1
xv(dx).
Proof. of Theorem 1.14
The Levy-Ito decomposition(Proposition 1.12) shows that for every t, the ran-
dom variable X
c
t
+ X
l
t
+ X

t
converges almost surely to X
t
when tends to 0.
JUMP PROCESSES 11
Since almost sure convergence implies convergence in distribution, the character-
istic function of X
c
t
+X
l
t
+X

t
converges to the characteristic function of X
t
. Since
X
c
t
, X
l
t
and X

t
are independent,
E[exp{iz.(X
c
t
+ X
l
t
+ X

t
)}] = exp{
1
2
tz.Az + it.z}
exp{t
_
|x|1
(e
iz.x
1)v(dx)}exp{t
_
|x|1
(e
iz.x
1 iz.x)v(dx)
and this expression converges to (15) for every z when tends to 0.
When v(R
d
= (innite activity case), the set of jump times of every trajectory
of the Levy process is countable innite and dense in [0, [. The countability
follows directly from the fact that the paths are cadlag. to prove that the set of
jump times is dense [0, [, consider a time interval [a, b] and let
(n) = sup
_
r :
_
|x|r
v(dx) n
_
and
Y
n
=
_
(n)|x|<(n1),t[a,b]
J
X
(dx dt)
Then, if the Levy measure has no atoms, Y
i
are independent and identically Poisson
distributed Poisson random variables. The total number of jumps in the interval
[a, b] is equal to

i=1
Y
i
, hence, by the law of large numbers, it is almost surely
innite. Since this is true for every nonempty time interval [a, b] , this means
that the set of jump times is dense in [0, [. The proof can be easily modied to
include the case when Levy measures has atoms.
Since an innitely divisible distribution is the distribution at time t = 1 of some
Levy process, the Levy-Khinchin formula also gives a general representation for
the characteristic function of any innitely divisible distribution:
Theorem 1.15. Characteristic function of innitely divisible distribu-
tions Let F be an innitively divisible distribution on R
d
. Its characteristic func-
tion can be represented as:

F
(z) = e

(z), z R
d
(z) =
1
2
z.Az + i.z +
_
R
d
(e
iz.x
1 iz.x1
|x|1
)v(dx)
where A is a symmetric positive n n matrix, R
d
and v is a positive Radon
measure on R
d
\{0} verifying:
_
|x|1
|x|
2
v(dx) <
_
|x|1
v(dx) < .
12 TANKOV-CONT
v is called the Levy measure of the distribution F.
1.4. Pathwise properties of Levy processes. Using the Levy-Ito decomposi-
tion, we deduce some properties of typical sample paths of a Levy process from
analytical properties of its characteristic triplet (A, v, ).
Piecewise constant trajectories: we saw in the above (Proposition 1.6) that
almost all trajectories of a Levy process are piecewise constant i it is of compound
Poisson type. Combining this with equation (4), which gives the characteristic
function of a compound Poisson process, we obtain the following:
Proposition 1.16. A Levy process has piecewise constant trajectories if and only
if its characteristic triplet satises the following conditions: A = 0,
_
R
d
v(dx) <
and =
_
|x|1
xv(dx) or equivalently, if its characteristic exponent is of the form:
(z) =
_

(e
iux
1)v(dx) with v(R
d
) <
Levy processes of nite variation: we recall that the total variation of a
function f : [a, b] R
d
is dened by
TV (f) = sup
n

i=1
|f(t
i
) f(t
i1
)|,
where the supremum is taken over all nite partitions a = t
0
< t
1
< < t
n1
<
t
n
= b of the interval [a, b]. In particular, in one dimension every increasing or
decreasing function is of nite variation and every function of nite variation is
a dierence of two increasing functions. A Levy process is said to be of nite
variation if its trajectories are functions of nite variation with probability 1.
Proposition 1.17. Finite variation Levy process A levy process is of nite
variation if and only if its characteristic triplet (A, v, ) satises:
A = 0 and
_
|x|1
|x|v(dx) < (16)
Proof. of Proposition 1.17 The if part. Under the stated conditions, X
t
can be
represented in the following form :
X
t
= bt +
_
|x|1,s[0,t]
xJ
X
(ds dx) + lim
0
X

t
,
where

t
=
_
|x|<1,s[0,t]
xJ
X
(ds dx).
The rst two terms are of nite variation, therefore we only need to consider the
third term. Its variation on the interval [0, t] is
TV (

X

t
) =
_
|x|<1,s[0,t]
|x|J
X
(ds dx)
JUMP PROCESSES 13
Since the integrand in the right-hand side is positive, we obtain, using Fubinis
theorem
E[TV (

X

t
)] = t
_
|x|<1
|x|v(dx)
which converge to a nite number as 0.
For the only if part. Consider the Levy-Ito decomposition (11) of X
t
. Since the
variation of any cadlag function is greater or equal to the sum of its jumps, we
have for every > 0:
TV (X
t
)
_
|x|<1,x[0,t]
|x|J
X
(ds dx)
= t
_
|x|<1,x[0,t]
|x|v(dx) +
_
|x|<1,x[0,t]
|x|(J
X
(ds dx) v(dx)ds).
Using the exponential formula on can show that the variance of the second term
in the last line is equal to
t
_
|x|<1,x[0,t]
|x|
2
v(dx).
Hence by the same argument that was used in the proof for Levy-Ito decomposition,
the second term converges almost surely to something nite.
Therefore in the condition
_
(|x|)v(dx) < is not satised, the rst term in
the last line will diverge and the variation of X
t
will be innite. Suppose now that
this condition is satised. This means that X
t
may be written as
X
t
= X
c
t
+
_
[0,t]R
d
xJ
X
(ds dx).
where the second term is of nite variation. Since trajectories of Brownian motion
are almost surely of innite variation (see Revuz and Yor (1999)), if A is nonzero,
X
t
will also have innite variation. Therefore we must have A = 0.

The proposition shows that in the nite variation case Levy-Ito decomposition
and Levy-Khinchin representation can be simplied:
Corollary 1.18. Levy-Ito decomposition and Levy-Khinchin represen-
tation in the nite-variation case
Let (X
t
)
t0
be a Levy process of nite variation with Levy triplet given by
(v, a, ). Then X can be expressed as teh sum of its jumps between 0 and t and a
linear drift term:
X
t
= bt +
_
[0,t]R
d
xJ
X
(ds dx) = bt +
X
s
=0

s[0,t]
(17)
14 TANKOV-CONT
and its characteristic function can be expressed as:
E[e
iz.X
t
] = exp t
_
ib.z +
_
R
d
(e
iz.x
1)v(dx)
_
(18)
where b =
_
|x|1
xv(dx).
The Levy triplet of X is not given by (b, 0, ) but by (, 0, v). As mentioned
before, is not an intrinsic quantity and depends on the truncation function used
in the Levy-Khinchin representation while bt has an intrinsic interpretation as the
continuous part of X.
Increasing Levy processes (subordinators). Increasing Levy processes are
also called subordinators because they can be used as time changes of other Levy
process (see next section). They are important ingredients for building Levy-based
models in nance.
Proposition 1.19. Let (X
t
)
t0
be a Levy process on R. The following conditions
are equivalent:
(1) X
t
0 a.s. for some t > 0.
(2) X
t
0 a.s. for every t 0.
(3) Sample paths of (X
t
) are almost surely nondecreasing: t s X
t
X
s
a.s.
(4) The characteristic triplet of (X
t
) satises A = 0, v((, 0]) = 0,
_

0
(x
1)v(dx) < and b 0, that is (X
t
) has no diusion component, only
positive jumps of nite variation and positive drift.
Proof. of Proposition 1.19
(1) (i iii) For every n, X
t
is a sum of n i.i.d. random variables X
t/n
, X
2t/n

X
t/n
, . . . , X
t
X
(n1)t/n
. This means that the variable are almost surely
nonnegative. With the same logic we can prove that for two rationals p
and q such that 0 < p < q, X
qt
X
pt
0 a.s. Since teh trajectories are
right-continuous, this entails that they are nondecreasing.
(2) (iii ii) is trivial.
(3) (iv iii) Under the conditions of (iv) the process if of nite variation,
therefore equal to the sum of jumps plus an increasing linear function. For
every trajectory, the number of negative jumps on a xed interval is a
Poisson random variable with intensity 0, hence almost surely zero. This
means that almost every trajectory is nondecreasing.
(4) (iii iv) Since the trajectories are nondecreasing, they are of nite vari-
ation. Therefore, A = 0 and
_

(x 1)v(dx) < . For trajectories to be

nonincreasing, there must be no negative jumps, hence v(] , 0]) = 0.
If a function is nondecreasing then after removing some of its jumps, we
obtain another nondecreasing function. Then we remove all jumps from a
trajectory of X
t
, we obtain a deterministic function bt which must therefore
be non decreasing. This allows to conclude that b 0.
JUMP PROCESSES 15

The following proposition introduces an important example of subordinator.

Proposition 1.20. Let (X
t
)
t0
be a Levy process on R
d
and let f : R
d
[0, [
be a positive function such that f(x) = O(|X|
2
) when x 0. Then the process
(S
t
)
t0
dened by
S
t
=

st,X
s
=0
f(X
s
) (19)
is a subordinator.
Proof. of Proposition 1.20 Let us rst show that the sum in (19) converges to
something nite. By truncating large jumps we can suppose that for each s,
X
s
for some > 0 and f(X
s
) CX
2
s
for some C > 0. But then
E[S
t
] =
_
[0,t]R
f(x)dsv(dx) < (20)
Since all the terms in the sum are positive, this means that it always converges and
S
t
is almost surely nite for all t. The fact that S has independent and stationary
increments follows directly from independence and stationarity of increments of
X. To prove that its is continuous in probability one can once again suppose that
jumps of X
t
are bounded (because the compound Poisson part is always continuos
in probability). But then E[|S
t
S
s
|] 0 as s t. Therefore, S is continuous in
probability.
The choice f(x) = x
2
yield the sum of squared jumps
S
t
=

st,X
s
=0
|X
s
|
2
(21)
This process which by the above is a subordinator is usually denoted [X.X]
d
and
called the discontinuous quadratic variation of X.
1.5. Distributional properties. If (X
t
)
t0
is a Levy process the for any t > 0,
the distribution of X
t
is innitely divisible and has a characteristic function of
the form (15). However, X
t
does not always have a density: indeed, if X
t
is a
compound Poisson process we have
P(X
t
= 0) = e
t
(22)
so the probability distribution has an atom at zero for all t. But if X is not a
compound Poisson process, then X
t
has a continuous density; we give the following
result for d = 1 from Orey (1968):
Proposition 1.21. Let X be a real-valued Levy process with Levy triplet (
2
, v, ).
(1) If > 0 or v(R) = then X
t
has a continuous density p
t
() on R.
16 TANKOV-CONT
(2) If the Levy measure v veries
]0, 2[, liminf
0

|x|
2
dv(x) > 0 (23)
then for each t > 0, X
t
has a smooth density p
t
() such that
p
t
() C

(R) n 1,

n
p
t
x
n
(t, x)
|x|
0. (24)
These and other properties of the density may be obtained using the Levy-
Khinchin representation and the properties of the Fourier transform (see Sato
(1999), Chapter 5).
Relation between probability density and Levy density In the compound
Poisson case there is a simple relation between probability distribution at time t
and the jump size distribution/Levy measure. Let (X
t
)
t0
be a compound Poisson
process with intensity and jump size distribution f and (N
t
)
t0
be a number of
jumps of X on [0, t]. Then
P{X
t
A} =

n=0
P{X
t
A|N
t
= n}
e
t
(t)
n
n!
= e
t

0
+

n=1
f
n
(A)
e
t
(t)
n
n!
(25)
where f
n
denotes the n th convolution power of f, and
0
is the Dirac measure
concentrated at 0. As noted above, this probability measure does not have a
density because P{X
t
= 0} > 0.
However, if the jump size distribution has a density with respect to Lebesgue
measure, then the law of X
t
is absolutely continuous everywhere except at zero
(because convolution of absolutely continuous distribution is absolutely continuous
) i.e. the law of X
t
can be decomposed as
P{X
t
A} = e
t
1
0A
+
_
A
p
ac
t
(x)dx where
p
ac
t
(x) =

n=1
f
n
(x)
e
t
(t)
n
n!
x = 0.
where we denote the jump size density by f(x). p
ac
t
is the density conditional on
the fact that the process has jumped at least once. This implies in particular the
following asymptotic relation
lim
t0
1
t
p
ac
t
(x) = f(x) = v(x) x = 0,
JUMP PROCESSES 17
where v(x) is the Levy density. This means that the Levy density describes the
small time behaviour of the probability density.
This relation also gives the small time behaviour for expectations of functions
of X
t
: given any bounded measurable function f such that f(0) = 0,
lim
t0
1
t
E[f(X
t
)] = lim
t0
1
t
_
R
d
f(x)p
t
(dx) =
_
R
d
f(x)v(dx) (26)
In teh innite activity setting the classical asymptotic result for expectations (see
Sato (1999), Corollary 8.9) is weaker: it states that the formula (26) holds for
any bounded continuous function f vanishing in the neighbourhood of zero. More
results on the relation between probability density of X and Levy measure for
innite-activity processes may be found in Barndor-Nielsen (2000) and Ruschen-
dorf (2002).
Moments and cumulants The tail behaviour of the distribution of a Levy
process and its moments are determined by the Levy measure , as shown by the
following proposition, which is consequence of Sato (1999) (Theorem 25.3).
Proposition 1.22. Moments and cumulants of a Levy process Let (X
t
)
t0
be a Levy process on R with characteristic triplet (A, v, ). The n th absolute
moment of X
t
, E[|X
t
|
n
] is nite for some t or, equivalently, for every t > 0 if and
only if
_
|x|1
|x|
n
v(dx) < . In thsi case moments of X
t
can be computed from its
characteristic function by dierentiation. In particulars, the form of cumulants of
(X
t
) is especially simple:
E[X
t
] = t
_
+
_
|x|1
x v(dx)
_
,
c
2
(X
t
) = V ar X
t
= t
_
A +
_
i
nfty

x
2
v(dx)
_
,
c
n
(X
t
) = t
_

x
n
v(dx) for n 3.
This entails that all innitely divisible distributions are leptokurtic since c
4
(X
t
) >
0. Also, the cumulants of the distribution of X
t
increase linearly with t. In particu-
lar the kurtosis and skewness of X

(or, equivalently, of the increments X

t+
X
t
are given by:
s(X

) =
c
3
(X)
c
2
(X)
3/2
=
s(X
1
)

, k(X

) =
c
4
(X
)
c
2
(X
2

)
=
k(X
1
)

. (27)
Therefore the increments of a Levy process, or , equivalently, all innitely di-
visible distributions are always leptokurtic but the kurtosis (and skewness if there
is any) decreases with the time scale over which increments are computed: the
skewness fall at
1/2
while the kurtosis decays as 1/.
18 TANKOV-CONT
Proposition 1.23. Exponential moments Let (X
t
)
t0
be a Levy process on R
with characteristic triplet (A, v, ) and let u R. The exponential moment E[e
uX
t
]
is nite for some t or, equivalently, for all t 0 if and only if
_
|x|1
e
ux
v(dx) < .
In thsi case
E[e
uX
t
] = e
t(iu)
.
where is the characteristic exponent of the Levy process dened by (15).
For a proof see Sato (1999) (Theorem 25.17).
1.6. Stable laws and processes. A remarkable property of Brownian motion is
it selfsimilarity property: if W is a Wiener process on R then
a > 0,
_
W
at

a
_
t0
d
= (W
t
)
t0
.
If we consider a Brownian motion with drift B
t
= W
t
+t then this property is
only veried up to a translation:
a > 0,
_
B
at

a
_
t0
d
= (B
t
+

at)
t0
A natural question is whether there exist other real valued Levy processes that
share this selfsimilarity property: a Levy process X
t
is said to be selfsimilar if
a > 0, b(a) > 0 :
_
X
at
b(a)
_
t0
d
= (X
t
)
t0
Since the characteristic function of X
t
has the form

X
t
(z) = exp[t(z)]
this property is equivalent to the following property of the characteristic function:
a > 0, b(a) > 0 : Phi
X
t
(z)
a
=
X
t
(zb(a)) z.
The distribution that verify this property are called strictly stable distributions.
More precisely, we have the following denition.
Denition 1.24. A random variable X R
d
is said to have stable distribution if
r every a > 0 there exists b(a) > 0 and c(a) R
d
such that

X
(z)
a
=
X
(zb(a))e
ic.z
, z R
d
. (28)
It is said to have a strictly stable distribution if

X
(z)
a
=
X
(zb(a)), z R
d
. (29)
The name stable comes for the following stability under addition property: if X
has a stable distribution and X
(1)
+ + X
(n)
are independent copies of X then
there exists a positive number c
n
and a vector d such that
X
(1)
+ + X
(n)
d
= c
n
X +d. (30)
JUMP PROCESSES 19
This property is clearly veried if the distribution of X is that of selfsimilar Levy
process at a given time t. It can be show (see Samorodnitsky (1994), Corollary
2.1.3) that for every stable distribution there exists a constant (0, 2] such
that (28), b(a) = a
1/
. This constant is called the index of stability and stable
distributions with index are also referred to as stable distributions. the only
2-stable distributions are Gaussian.
A selfsimilar Levy process therefore has strictly stable distribution at all times.
For this reason, such processes are also called strictly stable Levy processes. A
strictly stable process satises:
a > 0,
_
X
at
a
1/
_
t0
d
= (X
t
)
t0
. (31)
In the case of the Wiener process = 2. More generally, an stable Levy process
satises this relation up to a translation:
a > 0, c R
d
: (X
at
)
t0
d
= (a
1/
X
t
+ ct)
t0
.
A stable Levy process denes a family of stable distributions and the converse
is true: every stable distribution is innitely divisible and can be seen as the
distribution at a given time of a stable Levy process. The following result gives
the form of characteristic triplet of all stable distributions (and therefore Levy)
Proposition 1.25. Stable distribution and Levy processes A distribution
on R
d
is stable with 0 < < 2 if and only if it is innitely divisible with
characteristic triplet (0, v, ) and there exists a nite measure on S, a unit
sphere of R
d
, such that
v(B) =
_
S
(d)
_

0
1
B
(r)
dr
r
1+
(32)
A distribution on R
d
is stable with = 2 if and only if it is Gaussian.
A proof is given in (Sato (1999), Theorem 14.3), see also Samorodnitsky (1994).
For real valued stable variables and Levy process (d=1) the above representation
can be made explicit: if X is a real-valued stable variable with 0 < < 2 then
its Levy measure is of the form
v(x) =
A
x
+1
1
x0
+
B
|x|
+1
1
x0
(33)
for some positive constants A and B. The characteristic function of a real-valued
stable random variable X has the form

X
(z) = exp
_

|z|

(1 i sgnz tan

2
+ iz
_
, if = 1

X
(z) = exp
_
|z|(1 + i
2

sgnz log |z|) + iz

_
, if = 1,
(34)
20 TANKOV-CONT
where (0, 2], 0, [1, 1] and R. In the sequel , a stable distribution
on R in this parametrization is denoted by S

(, , v). In this representation, is

the scale parameter (it has nothing to do with the Gaussian component if < 2),
is the shift parameter (when = 1 this is not true: (see Samorodnitsky (1994),
Section 1.2), determines the shape of the distribution and the skewness.
When = 0 and = 0, X is said to have a symmetric stable distribution and
the characteristic function is given by

X
(z) = exp(

|z|

).
The explicit form of the Levy measure (33) shows that stable distributions on
R never admit a second moment, and they only admit a rst moment if > 1.
The probability density of an stable law is not known in closed for except in
the following three cases
(1) The Gaussian distribution S
2
(, 0, ) with density
1
2

e
(x)
2
/4
2
(2) The Cauchy distribution S
1
(, 0, ) with density

((x )
2
+
2
.
(3) The Levy distribution S
1/2
(, 1, ) with density
_

2
1/2
_
1
(x )
3/2
exp
_

2(x )
_
1
x
While the rst two distributions are symmetric around their mean, the last one
is concentrated on (, ). Despite the fact that closed formulae for probability
density are only available in these three cases, closed-form algorithms for simulat-
ing stable random variables on R exists for all values of parameters (see Chapter
6 Cont and Tankov, 2004).
1.7. Levy processes as Markov processes. An important property of Levy
processes is the Markov property, which states that conditionally on X
t
, the evo-
lution of the process after time t is independent on its past before this moment.
In other words, for every random variable Y depending on the history F
t
of X
t
one must have
E[Y |F
t
] = E[Y |X
t
].
The transition kernel of process X
t
is dened as follows:
P
s,t
(x, B) = P{X
t
B|X
s
= x}, B B (35)
The Markov property implies the following relation between transition kernels
(known as the Chapman-Kolmogorov equations):
P
s,t
(x, B) =
R
d P
s,t
(x, dy)P
t,u
(y, B).
JUMP PROCESSES 21
It can be seen from (35) that the transition kernels of Levy processes are homoge-
neous in space and time, that is,
P
s,t
(x, B) = P
0,ts
(0, B x).
Levy processes are completely characterised by this condition (see Sato (1999),
Theorem 10.5): they are the only Markov process which are homogenous in space
and time.
Levy processes satisfy a stronger version of the Markov property, namely, for
all t, the process (X
t+s
X
t
)
s>0
has the same law as the process (X
s
)
s>0
and its
independent from (X
s
)
0st
.
Finally, the strong Markov property of Levy processes allows to replace the
nonrandom time t by any nonrandom time which is nonanticipating with respect
to the history of X (see section 2.4.2): if is a nonanticipating random time, the
the process Y
t
= X
t+
X
t
is again a Levy process, independent from F

and with
same law as X
t
)
t>0
.
The transition operator for Markov processes is dened as follows:
P
f
(x) = E[f(s + X
t
]
Chapman-Kolmogorov equations and the time homogeneity of transition kernels
imply the following semigroup relation between transition operators:
P
t
P
s
= P
t+s
(36)
Let C
0
be the set of continuous functions vanishing at innity. then for any t > 0,
P
t
f C
0
and
x lim
t0
P
t
f(x) = f(x).
where the convergence is in the sense of supremum norm on C
0
. This property is
called the Feller property. A semigroup P
t
verifying the Feller property (36) can
be described by means of its innitesimal generator L which is a linear operator
dened by
Lf = lim
t0
t
1
(P
t
f f). (37)
where the convergence is int the sense of supremum norm on C
0
and f should be
such that the right-hand side of 37 exists. The innitesimal generator of a Levy
process can be expressed in terms of its characteristic triplet.
Proposition 1.26. Innitesimal generator of a Levy process Let (X
t
)
t0
be a Levy process on R
d
with characteristic triplet (A, v, ). Then the innitesimal
22 TANKOV-CONT
generator of X is dened for any f C
2
0
(R) as
Lf(x) =
1
2
d

j,k=1
A
jk

2
f
x
j
x
k
(x) +
d

j=1

j
f
x
j
(x)
+
_
R
d
_
f(x + y) f(x)
d

j=1
y
j
f
x
j
(x)1
|y|1
_
d(dy),
(38)
where C
2
0
(R
d
) is the set of twice continuously dierentiable functions, vanishing at
innity.
For a proof see Sato, 1999 (Theorem 31.5).
1.8. Levy processes and martingales. The notion of martingale is crucial for
probability theory and mathematical nance. Dierent martingales can be con-
structed from Levy processes using their independent increments property.
Proposition 1.27. Let (X
t
)
t0
be a real-valued process with independent incre-
ments. Then
(1)
_
e
iuX
t
E[e
iuX
t ]
_
t0
is a martingale u R
(2) If for some u R, E[e
uX
t
] < t 0 then
_
e
uX
t
E[e
uX
t ]
_
t0
is a martingale.
(3) If E[X
t
] < t 0 then M
t
= X
t
E[X
t
] is a martingale (an also a
process with independent increments).
(4) if V ar[X
t
] < t 0 then (M
t
)
2
E[(M)
2
] is a martingale, where M is
the martingale dened above.
If (X
t
) is a Levy processes, for all of the processes of this proposition to be mar-
tingales it suces that the corresponding moments be nite for one value of t (see
Sato (1999), Theorems 25,17 and 25.3).
These statements follow from the independent increments property. Sometimes,
in particular in nancial applications, it is important to check whether a given
Levy process or its exponential is a martingale. We will now obtain the necessary
and sucient conditions.
Proposition 1.28. Let (X
t
)
t0
be a Levy process on R with characteristic triplet
(A, v, ).
(1) (X
t
)
t0
is a martingale if and only if
_
|x|1
|x|v(dx) < and
+
_
|x|1
x v(dx) = 0.
JUMP PROCESSES 23
(2) e
X
t
is a martingale if and pnly if
_
|x|1
e
x
v(dx) < and
A
2
+ +
_

(e
x
1 x1
|x|1
v(dx) = 0.
This proposition is a consequence of Proposition 1.12 and the Levy-Khinchin
formula.