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Drifted Brownian motion: hit 3 before -5

Question

Let Xt=mt+WtX_t=mt+W_t, where WW is standard Brownian motion and mm is a constant drift, starting from X0=0X_0=0.

(a) What is the probability that XX reaches 33 before it reaches −5-5?

(b) Now remove the upper barrier and suppose m>0m>0. What is the probability that XX ever reaches −5-5?

Short answer

(a) e10m−1e10m−e−6m\dfrac{e^{10m}-1}{e^{10m}-e^{-6m}} (or 5/85/8 if m=0m=0); (b) e−10me^{-10m}. e−2mXte^{-2mX_t} is a martingale, so optional stopping gives p e−6m+(1−p)e10m=1p\,e^{-6m}+(1-p)e^{10m}=1, which solves for pp. For (b), let the upper barrier go to infinity: the hitting probability of −5-5 becomes e−2m⋅5e^{-2m\cdot5}.

Adapted from Zhou, A Practical Guide to Quantitative Finance Interviews, sec. 5.4 Brownian Motion and Stochastic Calculus, 'Stopping time C', p.132; question and answer rewritten by SelfMadeQuant.com.

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