Abstract
In this paper, we propose a way to construct a single forward-looking model for interest rates, which represents their evolution under both the Q-measure and P-measure (a joint measure model). As is well known, the market prices of contingent claims are independent of investor risk preferences. This means that risk preferences, and therefore real world processes, cannot be obtained from market prices alone. Using a new concept, the local price of risk, we present a simple way in which historical data can be used in conjunction with market prices to create a joint measure model for the short rate and estimate the real world drift in interest rates. The local price of risk can be used for a wide range of interest rate models.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
