The Voice of Physics in Finance: A Glance on the Theoretical Application of Heat Equation to Stock Price Diffusions

Leonard Mushunje (Midlands State University, Department of Applied Mathematics and Statistics, Zimbabwe)

Abstract


Stock price volatility is considered the main matter of concern within the investment grounds. However, the diffusivity of these prices should as well be considered. As such, proper modelling should be done for investors to stay healthy-informed. This paper suggest to model stock price diffusions using the heat equation from physics. We hypothetically state that, our model captures and model the diffusion bubbles of stock prices with a better precision of reality. We compared our model with the standard geometric Brownian motion model which is the wide commonly used stochastic differential equation in asset valuation. Interestingly, the models proved to agree as evidenced by a bijective relation between the volatility coefficients of the Brownian motion model and the diffusion coefficients of our heat diffusion model as well as the corresponding drift components. Consequently, a short proof for the martingale of our model is done which happen to hold.


Keywords


Stock prices; Volatility; Diffusion; Heat equation; Brownian motion model; Physics

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DOI: https://doi.org/10.30564/jesr.v4i1.2700

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