Snell envelope
The Snell envelope, used in stochastics and mathematical finance, is the smallest supermartingale dominating a stochastic process. The Snell envelope is named after James Laurie Snell.
Definition
Given a filtered probability space and an absolutely continuous probability measure
then an adapted process
is the Snell envelope with respect to
of the process
if
-
is a
-supermartingale
-
dominates
, i.e.
-almost surely for all times
- If
is a
-supermartingale which dominates
, then
dominates
.[1]
Construction
Given a (discrete) filtered probability space and an absolutely continuous probability measure
then the Snell envelope
with respect to
of the process
is given by the recursive scheme
for
Application
- If
is a discounted American option payoff with Snell envelope
then
is the minimal capital requirement to hedge
from time
to the expiration date.[1]
References
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