J
JohnnySinz
Member
Hoping someone can provide an intuitive explanation of this section of CT8; I am struggling immensely to grasp this concept.
All I understand ATM is that the probability measure Q provides a no-arb. pricing mechanism for options and P -> Q changes the stock's drift from mew to r.
What I am having trouble understanding is the use of the all the intermediary steps in the derivation of these results, specifically the Radon-Nikodym derivative. Here is a question from my university's past paper below:
Let Xt be a stochastic process defined by Xt = exp{σWt} ; Wt is brownian.
Find the following:
E[Xt*(dQ/dP)|Sigma-S] / E[dQ/dP|Sigma-S]
and E[(dQ/dP)^2|Sigma-S] / E[dQ/dP|Sigma-S]
where dQ/dP = exp{σWt− (σ^2*t)/2}
The solutions make sense algebraically although I fail to see the reasoning behind the steps :/
Any help would be greatly appreciated.
All I understand ATM is that the probability measure Q provides a no-arb. pricing mechanism for options and P -> Q changes the stock's drift from mew to r.
What I am having trouble understanding is the use of the all the intermediary steps in the derivation of these results, specifically the Radon-Nikodym derivative. Here is a question from my university's past paper below:
Let Xt be a stochastic process defined by Xt = exp{σWt} ; Wt is brownian.
Find the following:
E[Xt*(dQ/dP)|Sigma-S] / E[dQ/dP|Sigma-S]
and E[(dQ/dP)^2|Sigma-S] / E[dQ/dP|Sigma-S]
where dQ/dP = exp{σWt− (σ^2*t)/2}
The solutions make sense algebraically although I fail to see the reasoning behind the steps :/
Any help would be greatly appreciated.