Solution

ID: past-exam-of-the-mathematics-course-of-the-university-of-cambridge/2012/iii/paper-44/4/b/solution

Apply the Itô product rule and the quadratic covariation rule for a stochastic integral. The finite variation consumption term has zero quadratic covariation with , so
Using and the wealth equation,
Thus the deflated wealth equation with consumption is
No finite variation assumption on is needed: the self-financing equation and the stochastic-integral quadratic covariation rule already incorporate the portfolio's financing constraint.

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