Itô′s formula with respect to fractional Brownian motion and its application

Abstract

Fractional Brownian motion (FBM) with Hurst index 1/2 < H < 1 is not a semimartingale. Consequently, the standard Itô calculus is not available for stochastic integrals with respect to FBM as an integrator if 1/2 < H < 1. In this paper we derive a version of Itô′s formula for fractional Brownian motion. Then, as an application, we propose and study a fractional Brownian Scholes stochastic model which includes the standard Black‐Scholes model as a special case and is able to account for long range dependence in modeling the price of a risky asset. This article is dedicated to the memory of Roland L. Dobrushin.