Differential Geometry ideas in Financial Mathematics T.Venkatesh Department of Mathematics KUKRC P.G.

Centre, Belgaum 591156 India E-mail tmathvenky @yahoo.co.in

1. Introduction

The events at the turn of the 20th century would justify the title of this paper. Around this time for mathematics the things were happening in a big way. Historically one would even notice that significant contribution to the understanding the nature of problems were taking shape in the guise of mathematics. Euclids frame work for geometry (His Euclidean Geometry what we study even now ) and development of calculus done independently by both Newton and Leibnitz thoroughly formalized mathematics and the problems of Physical Sciences considerably. Under this back drop we take stock of some exciting developments that have taken place in contemporary mathematics. The calculus methods that were developed on Euclidean spaces got extended to abstract spaces(Manifolds) and this what constituted is Differential Geometry and global analysis really on global scale took of in the work of several people in the early part of twentieth century. Locally these manifolds were regarded as Euclidean spaces and geometry was all about smoothness. In other words, we want the space to be of constant sectional curvature. As curvature and topology were intimately related this really interested the Physicists more than anybody else. A profound tradition of the Probability theory began during the time of Laplace in France. At the turn of the 20th century this took firm roots in the work of Emile Borel and Henri Lebesgue. These two together were lying the foundation on which A.N. Kolomogorov developed the axiomatic system to model a probability space. Indeed this was generally accepted as the standard one for the mathematical analysis of random phenomena. Some parallel developments were supplementing these great ideas in which differential geometry figured in good measure justifying the un seemingly related themes on one hand the pure mathematical abstractions and on the other hand some real world problems. Quite interestingly ,Louis Bacheliar a student of Henri Poincare was constructing a model in financial industry to price an option( a stock) which was much ahead of his times,[ ],[ ]. It also marked the beginning of the birth of a new theory in Finance. Close on to the heels is the work of Einstein who

wrote a series of papers relating to the problems he was contemplating around that time. We saw a series of papers appearing during the years 1905 to1917. Brownian motion that he discussed in one of his paper had parallels to Bacheliers work in Mathematics of Finance. This tradition continued with P aul Levy ( once again in France) whose understanding of the stochastic processes became the basis for much of the work that probabilists have done in pushing analysis further. In order to understand the thread of ideas encompassing geometry and analysis we may have to gain a firsthand knowledge of the themes which are seemingly unrelated. In the subsequent sections we unfold some of these ideas. 2. Differential Geometry setting The familiar Rn are the prototypes for differentiable manifolds. However some non trivial examples are those which are non Euclidean arising from the quotient topology of Rn. Contrary to the real line, as one dimensional manifold the unit circle which is obtained by quotienting R with the additive group of integers Z. This is also an embedding as a space in the two dimensional plane R2. Now taking the Cartesian product of these quotiented spaces with the as many copies of R one would get a smooth differentiable manifold of that desired dimension. Thus one can construct a Torus which is a closed compact surface. From the familiar results of Topology such quotiented spaces are constructed by attaching handles to the sphere. Up to homeomorphism all closed surfaces(2-dimensional) is either a 2-sphere, a Torus T2 or a torus with n handles. For three dimensional spaces the classification problem assumed a special significance. Thurstons Geometrisation conjecture was an elaborate program in this regard. We refer the reader to get a detailed account of this entire program of Thurston by suggesting the references cited here in,[ ],[ ]. Definition: A topological space M ( Hausdorff and admitting a countable base) endowed with a differentiable structure is called a differentiable manifold. The differentiable structure in the definition consists of an atlas A whose members are a pair (U, Phi) called a char or coordinate chart with U as a subset of M and all such Us covering M. And the map Phi on U into Rn is a local diffeomorphism. For the overlapping domains of the atlas members the transition maps are smooth, that is differentiable. An atlas description for Rn is trivial in the sense it can have just one chart member for the atlas with the identity map defined on the domain of the chart. Where as the examples such the unit circle and Torus require at least two chart members for the atlas on them anon trivial situation indeed. Charts provide the domain knowledge for the local features of the space and geometry to commensurate with the geometry of the ambient space. We have more issues here to sort out for the geometry via an intrinsic metric as envisioned by Riemann contrast to the Euclidean metric. To put it in the lay mans language the Topology and Geometry have to be understood in knowing the shape of an object in terms of metric(distance) and curvature. Topology is a concept of a space and hardly matters the way we measure the distance. In that sense topology describes a space much less precisely than geometry does. We need to know all the details of a space to measure the distance between any two

points. Then the sum of all these details which spell out the curvature at every point is what we mean by geometry. A coffee cup and a donut have the same topology but they have different shape or geometry. Similarly , a sphere and an ellipsoid have the same topology but they have different shapes. The sphere is a topological space with no fundamental group as every closed loop can be shrunk to a point continuously. But on the surface of a torus there are closed curves that can not be shrunk to a point continuously. Riemann and Ricci were trying to understand the geometry from an abstract point of view which also helped Einstein to treat the space and time as one entity rather than treating them as separate entities. Through his special relativity he was trying to provide a fundamental description to gravity in terms of curvature. Ricci curvature is special type of curvature which would enable us to describe the distribution of matter in spacetime, [ ],[ ]. In an abstract space one do not generally have a dot product but an inner product can be expected . In the absence a dot of product there is no way of developing the geometry of the space .Then what is this Riemannian metric?.In order to define this metric we need to define what is tangent space to manifold and then how one would consider certain geometric objects that is very much important to our study. For a smooth manifold M of dimension n let Tx M denote the set of all tangent vectors to M attached at x of M. then it is not hard to notice that TxM is an isomorphic of Rn.TxM is called the tangent space of M at x. The linear isomorphism between TxM and Rn will enable us to introduce an inner product in TxM which continuously as x varies over M. It was Riemann who introduced this inner product on M and manifold endowed with such a metric called a Riemannian manifold observe that Rn proves to be a particular case of a Riemannian manifold . For basic knowledge about Riemannian Geometry we refer the reader to [ ].[ ]. Non linear PDEs and Geometry gave some big surprises. It all began in the work of James Eells on Global Analysis,[ ]. As geometry transcended from Euclid to Riemann a similar metamorphosis took place in calculus. It is from Newton to K.Ito. In the 40s when Kolomogorov provided an axiomatic probability model to the random phenomina. The Brownian motion on Euclidean space from the probability view point took an interesting shape. Differential geometers were trying to understand the geometric evolution under continuous time parameter in terms of certain curvature flows. R.Hamilton was the one to initiate this study through his Ricci Flow techniques in Riemannian manifolds,[ ],[ ]. The flow here is a differential equation, anon-linear PDE(heat Equation) which evolves the geometry of a space guided by its curvature,that is how the space is curved.He could thus establish some stiking results pertaining to the shape(topology) of positively curved three and four dimensional spaces. A primary goal thus was to classify all shapes in dimension three and in particular to resolve the Poincare conjecture.Hamiltons program was completed in the brilliant work of Grigory Perelman. Hamiltons Ricci Flow technique is regarded as one of the brilliant work in modern differential geometry,[ ],[ ]. 3. Understanding Brownian Motion In this section we will try to understand Brownian Motion which is central to most of the stochastic process that arise in various problems under random environment. The underlying space could be smooth manifold in which one has to introduce a probability measure on the measurable space . the sigma Algebra of sets is obtained from the chart members of the atlas on M. Since locally a manifold is Euclidean the product measure on Rn can be induced on M under

the local diffeomorphisms. Thus we have solid premise for defining Random walks on the measure space in a differentiable manifold when regarded as the sample space and sigma Algebra the power set of M.