Numerix: Real-World Equity & Volatility Behavior: Implications For Economic Scenario Generation
In the risk-neutral world, all investments grow, on average, at the risk-free rate. However, in reality, risky positions earn a premium depending on their sensitivities to market factors. For instance, a call on an equity index is seen to earn a premium, while a put is seen to pay a premium.
Thus, while risk-neutral dynamics are ideal for producing valuations and hedge ratios, risk must be assessed with reference to real-world dynamics. Real-world dynamics incorporate risk premia, and this
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