Suppose that the short rate is 4% and its real-world processis:
dr = 0.1(0.05 – r)dt + 0.01dz
While the risk-neutral process is:
dr = 0.1(0.11 – r)dt + 0.01dz
First Question:
What is the market price of interest rate risk?
Second Question: What is the expected returnand volatility for a 5-year
zerocoupon bond in the risk-neutral world?
Third Question: What is the expected return andvolatility for a 5-year zerocoupon bond in the real world?
Expert Answer
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