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