Exercise 23.1
We take as given an interest rate model with the following P-dynamics for the short rate.
(a) Show that, under any martingale measure Q, the price process II (t) has a local rate of return equal to the short rate of interest. In other words, show that the stochastic differential of II (t) is of the form
(b) Show that the normalized price process
is a Q-martingale.
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