hard · Quantitative Finance

According to Girsanov's Theorem, what is the effect of changing from the physical probability measure mathbbP to the risk-neutral measure mathbbQ on the volatility of an asset?

1. The volatility becomes a stochastic process governed by the Radon-Nikod'ym derivative.
2. The volatility remains unchanged, while the drift is adjusted to the risk-free rate r.
3. The volatility σ is scaled by the market price of risk θ = (μ - r)/(σ).
4. The volatility must be set to zero to ensure the discounted price process is a martingale.

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