Hi, I can follow the solution in the examiners report no problems. I have a question as to why the drift and vol term At and Bt cannot be taken directly from the equation drt=alpha*(mew-rt)*dt + sigma*dZt ie drift/At = alpha*(Mew-rt) and vol/Bt = sigma? Should this not give you the same SDE for Xt, as Xt is a stochastic process and the underlying stochastic process for Xt is rt? This is similar to the acted notes chapter 10 question 10.7 where Yt was a function of Xt? Thanks, Darragh
I think the examiners were just being helpful in giving the hint! The difference in approach is between whether Ito's Lemma or Taylor's formula is employed. Both methods will, of course, lead to the same result.
