Remarks on Real-World Models
Pp. 149-164 (16)
This chapter presents some remarks about real-world modeling. First,
we examine the numerical differences between real-world simulations and riskneutral
simulations, comparing the drift terms in each type of model.
Next, we investigate the reason that the market price of risk is negative by
using a simplified model, which we refer to as a flat yield model. This subject is
motivated by the following research question: Why does long-period observation
tend to imply a negative value for the market price of risk? We obtain an answer
to this question by introducing simplified models (specifically, the flat yield model
and the positive slope model).
Through this book, we have estimated the market price of risk under the
assumption that it is constant in the sample period. Addressing this, we examine
the validity of the constancy assumption for risk management by using a simplified
model. It is worth nothing here that Section 7.1 is basically the contents of Yasuoka
(2015), and Sections 7.2 and 7.3 are newly written for this book.
Constant market price of risk, Drift, Flat yield model, Interest
rate shock, Interest rate risk management, Long-period observation, Negative
price tendency, Null market price of risk, Positive slope model, Real-world
model, Risk management, Risk-neutral model, Time-varying market price of
Graduate School of Engineering Management, Shibaura Institute of Technology. 3-9-14 Shibaura, Minato-ku, Tokyo.