FoundationMultiple choice

Changing the measure · Part 1 of 4

Under the real-world measure PP a stock follows dSt=μSt dt+σSt dWtdS_t = \mu S_t\,dt + \sigma S_t\,dW_t with μ=10%\mu = 10\% and σ=20%\sigma = 20\%. The risk-free rate is r=2%r = 2\%.

Under the risk-neutral measure Q, what is the drift of the stock?

  1. ArS, so 2% a year
  2. BμS, so 10% a year: a change of measure cannot alter the dynamics
  3. C(μ − σ²/2)S, so 8% a year, the drift of the log price
  4. DZero, because risk-neutral means no expected growth

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Changing the measure, part 1 of 4 · QuantMax