Integration
Introduction to Mathematics
of Finance
Session 4
January 30, 2018
Integration
Outline
1 Integration
Integration
Estimating area with finite sums
5.1 Estimating with Finite Sums
Let’s try to find the area of the shaded region in the picture
This section shows ho
y time can all be appro
integral in Section 5.3
1
y ! 1 " x2 Area
The area of a region w
a collection of rectang
0.5
R mation.
EXAMPLE 1 Appr
x What is the area of t
0 0.5 1
y = 1 - x 2 , and betw
FIGURE 5.1 The area of the region tect might want to kno
there’s no simple geometric
R cannot formula
be found by described
a simple for calculating the by R. Unfo
geometry formula
areas of such curved regions (Example 1). areas of shapes having
Integration
Approximate through rectangles:
y y
y ! 1 " x2
(0, 1) (0, 1) 1 , 15 y ! 1 " x2
1 1 4 16
1 , 3 1 , 3
2 4 2 4
3 , 7
0.5 0.5 4 16
R R
x x
0 0.5 1 0 0.25 0.5 0.75 1
(a) (b)
FIGURE 5.2 (a) We get an upper estimate of the area of R by using two
rectangles containing R. (b) Four rectangles give a better upper estimate. Both
estimates overshoot the true value for the area.
While we do not yet have a method for determining the exact area of R, we can ap-
Integration
Upper sums
The area estimated this way is larger than
the true area.
1 3 1
A≈1· 2
+ · = 78 = 0.875
4 2
1 15 1
A≈1· 4
+ · + 34 · 14 + 16
16 4
7
· 41 = 25
32
= 0.78125
Integration
Lower and mid sums
5.1 Estimating with Finite Sums 327
y y
1 , 63
1 , 15 8 64
1 4 16
y ! 1 " x2 1
3 , 55
8 64 y ! 1 " x2
1 , 3
2 4
5 , 39
8 64
3 , 7
0.5 4 16 0.5
7 , 15
8 64
x x
0 0.25 0.5 0.75 1 0 0.25 0.5 0.75 1
0.125 0.375 0.625 0.875
(a)
(b)
FIGURE 5.3 (a) Rectangles contained in R give an estimate for the area that undershoots
the true value. (b) The midpoint rule uses rectangles whose height is the value of y = ƒsxd
at the midpoints of their bases.
Integration
Lower and mid sums
We are not only getting the approximations
but also the upper and lower bounds for the
estimates.
Lower sum:
A ≈ 15 · 1 + 43 · 14 + 16
16 4
7
· 41 + 0 · 14 = 17
32
= 0.53125
0.53125 < A < 0.78125, approximation error can not
be greater than the difference that is 0.25
Mid rule:
A ≈ 63 · 1 + 64
64 4
55 1
· 4 + 39 · 1 + 15
64 4 64 4
· 1 = 172
64
= 0.671875
Integration
Finite approximations for the area
TABLE 5.1 Finite approximations for the area of R
Number of
subintervals Lower sum Midpoint rule Upper sum
2 .375 .6875 .875
4 .53125 .671875 .78125
16 .634765625 .6669921875 .697265625
50 .6566 .6667 .6766
100 .66165 .666675 .67165
1000 .6661665 .66666675 .6671665
Table 5.1 shows the values of upper and lower sum approximations to the area of R us-
ing up to 1000 rectangles. In Section 5.2 we will see how to get an exact value of the areas
Integration
To approximate the area under the curve of a
function f (x) over the interval [a, b], proceed as
follows
Divide the interval into n subintervals of
equal widths 4x = (b − a)/n
let f (ck ) be the value of f at the chosen
point ck in the k th subinterval
then the finite sum is of the form
f (c1 )4x + f (c2 )4x + · · · + f (cn )4x
The value of the finite sum is the estimated area
under the curve
Integration
Sigma Notation
Finite Sums and Sigma Notation
Sigma notation enables us to write a sum with many terms in the compact form
Sigma notation enables us to write a sum
a aterms
n
with many k = a1 +in
a2 the + Á + an - 1 form
+ a3 compact + an .
k=1
n
The Greek letter ©X
(capital sigma, corresponding to our letter S), stands for “sum.”
ak us
index of summation k tells a1 +theasum
=where ··· +
2 +begins (ata n−1
the + abelow
number n the © sym
and where it ends (at the number above © ). Any letter can be used to denote the index,
k =1
the letters i, j, and k are customary.
The index k ends at k ! n.
n
The summation symbol
(Greek letter sigma)
ak a k is a formula for the kth term.
k!1
The index k starts at k ! 1.
Integration
This illustrates a general rule for finite sums:
a sak + bk d = a ak + a bk
Algebra rules for sums
n n n
k=1 k=1 k=1
Four such rules are given below. A proof that they are valid can be obtained using mathe-
matical induction (see Appendix 1).
Algebra Rules for Finite Sums
a (ak + bk) = a ak + a bk
n n n
1. Sum Rule:
k=1 k=1 k=1
a (ak - bk) = a ak - a bk
n n n
2. Difference Rule:
k=1 k=1 k=1
a cak = c a ak
#
n n
3. Constant Multiple Rule: (Any number c)
k=1 k=1
ac = n c
#
n
4. Constant Value Rule: (c is any constant value.)
k=1
Integration
The limit of finite approximations to an area
Consider the example of approximating f (x) = 1 − x 2 over
the region [0, 1] using lower sums
Divide the region [0, 1] into n rectangles of equal
width 4x = (1 − 0)/n
The subintervals becomes
1 1 2 n−1
0, , , ,··· . ,n
n n n n
Since 1 − x 2 is a decreasing function, the lower
value of the function would be at the right endpoint
of the interval. Calculate the sum
n 1
1 1 2 1
f +f , · · · .f
n n n n n n
Integration
In sigma notations, this is
n n 2 !
X k 1 X k 1
f = 1−
n n n n
k =1 k =1
..
.
2n3 + 3n2 + n
= 1−
6n3
Now let n → ∞, we get
2n3 + 3n2 + n
2 2
lim 1 − = 1 − = = 0.666̄
n→∞ 6n3 6 3
Integration
Riemann sums
Let [a, b] be divided into n subintervals
[x0 , x1 ], [x1 , x2 ], · · · , [xn−1 , xn ]
The width of first interval is x1 − x0 = 4x1
and of k th interval is 4xk = xk − xk −1
Then the sum
n
X
SP = f (ck )4xk
k =1
is the Riemann sum where f (ck ) is the point
chosen in the k th subinterval
Integration
The definite integral as a limit of Riemann sums
Let f (x) be a function on a closed interval [a, b].
We say that a number I is the definite integral of
f over P[a, b] and that I is the limit of the Riemann
sums nk =1 f (ck )4xk if the following condition is
satisfied:
Given any number > 0 there is a
corresponding number δ > 0 such that for every
partition P = {x0 , x1 , · · · , xn } of [a, b] with
kPk < δ and any choice of ck in [xk −1 , xk ], we
have
n
X
| f (ck )4xk − I| <
Integration
The fundamental theorem of calculus
Rx
If f is continuous on [a, b] then F (x) = a f (t)dt
is continuous on [a, b] and is differentiable on
(a, b) and its derivative is f (x):
Z x
0 d
F (x) = f (t)dt = f (x)
dx a
Integration
Examples
d
Rx
dx a cos tdt
d
Rx 1
dx a 1+t 2 dt
Integration
The fundamental theorem of calculus - part 2
If f is continuous at every point of [a, b] and F is
any antiderivative of f on [a, b], then
Z b
f (x)dx = F (b) − F (a)
a
Integration
Example
Rπ
0 cos xdx = sin π − sin 0 = 0
R4 3
√ 4
1 2 x − x2
=?
Integration
Where do we need integrals?
How do we measure interest rates?
The return received on a bank account
Let’s say at time t = 0, you invested M0 in a
bank
Time t value of the bank account is Mt
The change in the amount deposited in
bank over a small time horizon dt is then
dMt = rMt dt
Integration
The solution of this equation is Mt = M0 ert
What if the interest rates are not constant,
and are function of time r (t)?
What if the interest rates are random?
Integrals are also used in finding
probabilities (or expectations) of continuous
random variables
