easy · Quantitative Finance stochastic
According to Girsanov's theorem, when transitioning from the real-world probability measure P to the risk-neutral measure Q, how is the drift of the asset price process dS_t = μ S_t dt + σ S_t dW_t modified?
- The drift is adjusted by adding the volatility drag term (1)/(2) σ^2.
- The drift μ is replaced by the risk-free rate r.
- The volatility σ is adjusted by the market price of risk.
- The drift μ is set to zero to ensure martingale property.
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