A risky asset has value 4, at time r. A probability measure R is defined so...

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A risky asset has value 4, at time r. A probability measure R is defined so that Ay is an R-martingale, where v is calculated using the risk-free interest rate. Explain why R can be described as a risk-neutral probability measure. [2] (ii) Let X, =v¹E₂ [CF,], where C is a discrete random variable occurring at time T>1. Prove that X, is an R-martingale. [2] Hint: if X is a discrete random variable and Y is a vector of random variables, then E[E[XIX]]-E[X]. (ii) Stating any results that you use, deduce that , is previsible, where dX, 8,dD,, where D, AV. - = [2] A risky asset has value 4, at time r. A probability measure R is defined so that Ay is an R-martingale, where v is calculated using the risk-free interest rate. Explain why R can be described as a risk-neutral probability measure. [2] (ii) Let X, =v¹E₂ [CF,], where C is a discrete random variable occurring at time T>1. Prove that X, is an R-martingale. [2] Hint: if X is a discrete random variable and Y is a vector of random variables, then E[E[XIX]]-E[X]. (ii) Stating any results that you use, deduce that , is previsible, where dX, 8,dD,, where D, AV. - = [2]

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ANSWER i The fact that 4v is an Rmartingale implies that the expected value of 4v at any future time ... View the full answer