";?>
where
is a correlation factor.
The first component typically accounts for 80-90% (and the first three
for up to 95-99%) of the variance observed in the market price of forward
rates [19].
Note that the forecast value for the price of a share
or an
interest rate
constructed using Wiener increments depends
only the present value: this independence from the past is known in
mathematics as the Markov property.
Also note that a suitable choice of a
numeraire can always be found to normalize
random variables and make them risk-neutral by scaling out the drift observed
in the real world: called martingales,
such variables play an important role in the construction of financial models.
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