AppliedMultiple choice

Changing the measure · Part 2 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\%.

The Brownian motions are related by dWtQ=dWt+θ dtdW^Q_t = dW_t + \theta\,dt. What is θ\theta?

  1. A0.4
  2. B0.08, the excess return μ − r
  3. C0.5, the ratio μ/σ
  4. D−0.4, since risk-neutral pricing lowers the drift

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Changing the measure, part 2 of 4 · QuantMax