Drift and the Risk-Free Rate.pdfVIP

Hindawi Publishing Corporation Journal of Probability and Statistics Volume 2011, Article ID 595741, 19 pages doi:10.1155/2011/595741 Research Article Drift and the Risk-Free Rate Anda Gadidov1 and M. C. Spruill2 1 Department of Mathematics and Statistics, Kennesaw State University, Kennesaw, GA 30144-5591, USA 2 School of Mathematics, Georgia Institute of Technology, Atlanta, GA 30332-0160, USA Correspondence should be addressed to M. C. Spruill, spruill@ Received 5 May 2011; Revised 27 June 2011; Accepted 2 July 2011 Academic Editor: Arjun K. Gupta Copyright q 2011 A. Gadidov and M. C. Spruill. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. It is proven, under a set of assumptions differing from the usual ones in the unboundedness of the time interval, that, in an economy in equilibrium consisting of a risk-free cash account and an equity whose price process is a geometric Brownian motion on 0, ∞, the drift rate must be close to the risk-free rate; if the drift rate μ and the risk-free rate r are constants, then r μ and the price process is the same under both empirical and risk neutral measures. Contributing in some degree perhaps to interest in this mathematical curiosity is the fact, based on empirical data taken at various times over an assortment of equities and relatively short durations, that no tests of the hypothesis of equality are rejected. 1. Introduction In the Black-Scholes model of a market with a single equity, its price St is a geometric Brownian motion GBM satisfying for time t ≥ 0 the stochastic differential equation