Tag Info

Hot answers tagged

5

It depends on the purpose of your simulation. If you want to model the asset price path for pricing some derivative then you need the risk-neutral measure (thus you take the risk-less rate as drift). Why? Because the risk-neutral measure makes your pricing compatible with the pricing of other contracts in the market. It makes the prices consistent. If ...


5

The second theorem called "Girsanov II" is indeed a special case of the general "Girsanov I" from above with $$Y_t=W_t,$$$$X_t=-\int_0^t\Theta_udW_u$$. We can show that $$[Y,X]=-\int_0^t\Theta_udu$$ using general Stochastic Calculus rules (e.g. see p.37, 6.6 here): $$[Y,X]=[W_t,-\int_0^t\Theta_udW_u]=-\int_0^t\Theta_ud[W_u,W_u]=-\int_0^t\Theta_udu$$ since ...


2

Bond Price Dynamics I do not know the source of the bond dynamics you show above but seeing how we are dealing with an affine model there is a very elegant way to derive those. Due to the model being affine the bond price is given by $$P(t,T)=A(t,T)e^{-r(t)B(t,T)}$$ you can find the exact formulas for $A(t,T)$ and $B(t,T)$ in this document (or just read ...



Only top voted, non community-wiki answers of a minimum length are eligible