A topic in the Open Knowledge Graph — a free, open map of 15,290 topics and the order to learn them in.

Girsanov Theorem

Research Depth 182 in the knowledge graph ☐ I know this ☆ Set as goal
3topics build on this
1,140prerequisites beneath it
See this on the map →
Introduction to MartingalesStochastic Differential Equations+1 more→→Martingale Representation TheoremStochastic Calculus Applications in Finance
girsanov change-of-measure risk-neutral equivalent-measures

Core Idea

Girsanov's theorem describes how Brownian motion transforms under a change of probability measure. If W is a Brownian motion under P and we define a new measure Q via the Radon-Nikodym derivative dQ/dP = exp(-∫θ dW - (1/2)∫θ² dt), then W̃(t) = W(t) + ∫₀ᵗ θ(s) ds is a Brownian motion under Q. This allows removing or adding drift: a process with drift under one measure becomes driftless under another. It is the mathematical foundation of risk-neutral pricing in finance.

Explainer

Girsanov's theorem answers a remarkable question: if you change the probability measure on a probability space, what happens to the Brownian motion? The answer is that it acquires (or loses) a drift. Specifically, if W is a standard Brownian motion under probability measure P, and we define a new measure Q by the Radon-Nikodym derivative dQ/dP = Z(T), where Z(t) = exp(-∫₀ᵗ θ(s) dW(s) - (1/2)∫₀ᵗ θ(s)² ds) is the exponential martingale, then the process W̃(t) = W(t) + ∫₀ᵗ θ(s) ds is a standard Brownian motion under Q.

The exponential Z(t) is called the Girsanov density or likelihood ratio process. Your prerequisite on the Radon-Nikodym theorem ensures you understand what dQ/dP means: it is a non-negative measurable function that converts P-expectations to Q-expectations via E_Q[X] = E_P[Z·X]. The Novikov condition E_P[exp((1/2)∫₀ᵀ θ² dt)] < ∞ is the standard sufficient condition ensuring Z is a true martingale (E_P[Z(T)] = 1), so that Q is a genuine probability measure equivalent to P. Without this condition, Z could be a strict supermartingale with E[Z(T)] < 1, and Q would assign total mass less than 1 — a defective measure.

The practical power of Girsanov's theorem is drift removal. If under P we have dX = μ(t)dt + σ(t)dW, we can choose θ = μ/σ and switch to a measure Q under which dX = σ dW̃ — the drift has been absorbed into the new Brownian motion. This is the mathematical content of risk-neutral pricing in finance: under the real-world measure P, a stock has drift μ (its expected return). Under the risk-neutral measure Q (constructed via Girsanov with θ = (μ-r)/σ, where r is the risk-free rate), the stock has drift r. Option prices are expectations under Q, not P — Girsanov's theorem is the bridge between the physical and risk-neutral worlds.

A critical limitation: Girsanov's theorem changes drift but not volatility. The quadratic variation [X,X]_t is the same under both P and Q because equivalent measures agree on null sets, and quadratic variation is determined pathwise. This means the "roughness" of sample paths is an absolute property — no change of measure can smooth Brownian motion or eliminate diffusion. Drift is a statistical property (it determines which direction the process tends to go), while volatility is a pathwise property (it determines how rough the paths are). Girsanov lets you manipulate the former while the latter remains invariant.

Practice Questions 3 questions

Prerequisite Chain

Understanding Zero → The Number Zero → Counting to Five → Counting to 10 → Counting to 20 → Counting a Set of Objects Up to 20 → Cardinality: The Last Number Counted → Matching Numerals to Quantities → Subitizing Small Quantities → Addition Within 10 → Number Bonds to 10 → Addition Within 20 → Doubles and Near Doubles → Doubles Facts Within 10 → Near Doubles Facts Within 20 → Mental Math Strategies for Addition → Mental Math: Adding and Subtracting Tens → Addition Within 100 → Repeated Addition as Multiplication → Multiplication as Equal Groups → Multiplication: Arrays → Basic Multiplication Facts (0s, 1s, 2s, 5s, 10s) → Multiplication Facts Within 100 → Division as Equal Sharing → Division as Grouping (Measurement Division) → Division: Grouping (Repeated Subtraction) Model → Division: Fair Sharing Model → Division as Equal Sharing → Division as Grouping → Basic Division Facts → Division Facts Within 100 → Multiplication and Division Fact Families → Relationship Between Multiplication and Division → Division Facts as Inverse of Multiplication → Remainders and Quotients in Division → Division Word Problems → Multi-Step Word Problems → Solving Multi-Step Word Problems → Multiplication Word Problems → Division Word Problems → Introduction to Long Division → Factors and Multiples → Prime and Composite Numbers → Equivalent Fractions → Relating Fractions and Decimals → Decimal Place Value → Integers and the Number Line → Comparing and Ordering Integers → Absolute Value → Adding Integers → Subtracting Integers → Multiplying Integers → Dividing Integers → Unit Rates → Proportions → Percent Concept → Converting Between Fractions, Decimals, and Percents → Operations with Rational Numbers → Two-Step Equations → Solving Multi-Step Equations → Equations with Variables on Both Sides → Angle Pairs: Complementary, Supplementary, and Vertical → Parallel Lines and Transversals → Corresponding Angles → Alternate Interior Angles → Triangle Angle Sum Theorem → Exterior Angle Theorem → Triangle Inequality Theorem → Similar Triangles: AA Similarity → Similar Triangles: SSS and SAS Similarity → Proportions in Similar Triangles → Right Triangle Trigonometry Introduction → Sine, Cosine, and Tangent Ratios → Trigonometric Ratios Review → Radian Measure → Converting Between Degrees and Radians → The Unit Circle → Graphing Sine and Cosine → Graphing Tangent and Reciprocal Trigonometric Functions → Derivatives of Trigonometric Functions → Antiderivatives → Indefinite Integrals → Basic Integration Rules → Riemann Sums → Definite Integral Definition → Double Integrals: Definition and Setup → Iterated Integrals and Fubini's Theorem → Double Integrals over Rectangular Regions → Double Integrals over General Regions → Applications of Double Integrals: Area, Mass, and Moments → Triple Integrals in Cartesian Coordinates → Triple Integrals in Cylindrical and Spherical Coordinates → Change of Variables and the Jacobian Determinant → Applications of Triple Integrals: Volume and Mass → Vector Fields and Their Representations → Line Integrals of Vector Fields → Work and Circulation → Line Integrals of Scalar and Vector Functions → Fundamental Theorem for Line Integrals → Conservative Vector Fields → Conservative Vector Fields and Potential Functions → Curl and Divergence of Vector Fields → Curl and Divergence → Divergence Theorem → Electric Flux and Divergence Theorem → Gauss's Law: Integral Form and Meaning → Solving Problems with Gauss's Law → Conductors in Electrostatic Equilibrium → Capacitance and Capacitors → Dielectrics → Dielectric Constant and Relative Permittivity → Electric Field Inside Dielectric Materials → Dielectric Materials and Polarization → Dielectric Susceptibility and Permittivity → Energy Density in Electric Fields → Electric Current and Current Density → Electrical Resistance and Resistivity → Ohm's Law and Circuit Elements → Electromotive Force (EMF) and Batteries → Kirchhoff's Circuit Laws: Voltage and Current → DC Circuit Network Analysis Methods → Transient Response in RC Circuits → RC Circuits → LC and RLC Circuits → AC Circuits: Fundamentals → Impedance and Reactance → AC Power and Resonance → Electromagnetic Waves → Postulates of Special Relativity → Time Dilation → Length Contraction → Lorentz Transformation → Relativistic Velocity Addition → Relativistic Momentum and Energy → Mass-Energy Equivalence and E=mc² → Photons as Particles with Energy and Momentum → Planck-Einstein Relation: Energy and Frequency → Photoelectric Effect → The Photon: Light as Quanta → Compton Scattering → Wave-Particle Duality → de Broglie Wavelength → The Schrödinger Equation → State Vectors and Wavefunctions → Quantum Superposition → Quantum Entanglement → Bell Theorem and Bell Inequalities → Postulates of Quantum Mechanics → Observables and Quantum Operators → Commutators and Commutation Relations → Quantum Angular Momentum → Quantum Mechanical Treatment of Hydrogen → Solving the Schrödinger Equation for Hydrogen Atom → Quantum Numbers → Electron Configuration → Periodic Trends → Covalent Bonding → Electronegativity and Bond Polarity → Ionic Bonding → Lewis Structures → VSEPR Theory and Molecular Geometry → Molecular Geometry and Electron Pair Geometry → Molecular Polarity and Dipole Moments → Intermolecular Forces → States of Matter and Phase Changes: Melting, Boiling, and Sublimation → Gas Laws and the Ideal Gas Equation → Gas Stoichiometry and Volume-Volume Calculations → Thermochemistry and Enthalpy → Heat Capacity and Calorimetry → Entropy and Molecular Disorder → Spontaneity and ΔG → Entropy and Gibbs Free Energy → Chemical Equilibrium → Statistical Mechanics: Ensembles and the Boltzmann Distribution → Partition Function: Definition and Properties → The Canonical Partition Function and Thermodynamic Derivation → Maxwell-Boltzmann Distribution and Classical Limit → Brownian Motion → Properties of Brownian Motion → The Itô Integral → Itô's Formula (Itô's Lemma) → Stochastic Differential Equations → Girsanov Theorem

Longest path: 183 steps · 1140 total prerequisite topics

Prerequisites (3)

Leads To (2)