Basic affine jump diffusion

In mathematics probability theory, a basic affine jump diffusion (basic AJD) is a stochastic process Z of the form

: dZ_t=\kappa (\theta -Z_t),dt+\sigma \sqrt{Z_t},dB_t+dJ_t,\qquad t\geq 0, Z_{0}\geq 0,

where B is a standard Brownian motion, and J is an independent compound Poisson process with constant jump intensity l and independent exponentially distributed jumps with mean \mu . For the process to be well defined, it is necessary that \kappa \theta \geq 0 and \mu \geq 0 . A basic AJD is a special case of an affine process and of a jump diffusion. On the other hand, the Cox–Ingersoll–Ross (CIR) process is a special case of a basic AJD.

Basic AJDs are attractive for modeling default times in credit risk applications, since both the moment generating function

: m\left( q\right) =\operatorname{E} \left( e^{q\int_0^t Z_s , ds}\right) ,\qquad q\in \mathbb{R},

and the characteristic function

: \varphi \left( u\right) =\operatorname{E} \left( e^{iu\int_0^t Z_s , ds}\right) ,\qquad u\in \mathbb{R},

are known in closed form.

The characteristic function allows one to calculate the density of an integrated basic AJD

: \int_0^t Z_s , ds

by Fourier inversion, which can be done efficiently using the FFT.