On the control of the difference between two Brownian motions: a dynamic copula approach

TL;DR

This paper introduces new copula models for two Brownian motions to better control the distribution of their difference, including asymmetric dependencies, expanding beyond Gaussian copulas.

Contribution

It develops a novel copula framework based on reflection that captures asymmetric dependence and extends the class of admissible copulas for Brownian motions.

Findings

Copulae can produce higher right tail probabilities than Gaussian copulas.

Range of difference probabilities is the same for Markovian and all Brownian pairs.

New copula models include asymmetric dependence structures.

Abstract

We propose new copulae to model the dependence between two Brownian motions and to control the distribution of their difference. Our approach is based on the copula between the Brownian motion and its reflection. We show that the class of admissible copulae for the Brownian motions are not limited to the class of Gaussian copulae and that it also contains asymmetric copulae. These copulae allow for the survival function of the difference between two Brownian motions to have higher value in the right tail than in the Gaussian copula case. Considering two Brownian motions $B_t^1$ and $B_t^2$, the main result is that the range of possible values for $\mathbb{P}\left(B_t^1-B^2_t \geq \eta\right)$ with $\eta > 0$ is the same for Markovian pairs and all pairs of Brownian motions, that is $\left[0,2\Phi\left(\frac{-\eta}{2\sqrt{t}}\right)\right]$ with $\Phi$ being the cumulative distribution function of a standard Gaussian random variable.