what is the price risk? which has more price risk course hero

Verified Answer Interest rate (or price) risk means the risk that arises for bondholders in the form of price change of the security, due to a change in the interest rates. 10-year bond has more interest rate risk as compared to the 1-year bond. It happens because interest rates are more volatile in long-term than short-term.

Full Answer

Why does the market price of risk not appear?

There are some models in which the market price of risk does not appear because they typically involve using some form of utility theory approach to find a person's own price for an instrument rather than the market's. References and Further Reading.

What is the market price of risk for an option on that stock?

If a stock has a certain value for its market price of risk then an obvious question to ask is what is the market price of risk for an option on that stock? In the famous Black-Scholes world in which volatility is deterministic and you can hedge continuously and costlessly, then the market price of risk for the option is the same as that for the underlying equity. This is related to the concept of a complete market in which options are redundant because they can be replicated by stock and cash.

Why is there an explicit reference in the option pricing model?

This is because you cannot hedge away associated risk.

When you model stochastically a quantity that is not traded, then the equation governing the pricing of derivative?

When you model stochastically a quantity that is not traded, then the equation governing the pricing of derivatives is usually of diffusion form, with the market price of risk appearing in the 'drift term with respect to the non-traded quantity. To make this clear, here is a general example.

How is risk measured in economics?

Typically risk is measured by standard deviation of returns, or volatility. The market price of risk for a stock is measured by the ratio of expected return in excess ...

Is market price of risk observable?

Market price of risk is only observable through option prices. This is the point at which practice and elegant theory start to part company. Market price of risk sounds like a way of calmly assessing required extra value to allow for risk. Unfortunately there is nothing calm about the way that markets react to risk.