An approximation of It\^o diffusions based on simple random walks

Abstract

The aim of this paper is to develop a sequence of discrete approximations to a one-dimensional It\^o diffusion that almost surely converges to a weak solution of the given stochastic differential equation. Under suitable conditions, the solution of the stochastic differential equation can be reduced to the solution of an ordinary differential equation plus an application of Girsanov's theorem to adjust the drift. The discrete approximation is based on a specific strong approximation of Brownian motion by simple, symmetric random walks (the so-called "twist and shrink" method). A discrete It\^o's formula is also used during the discrete approximation.