When Pricing Through Monte Carlo Simulations on Trees We Are

question 4

Essay

When pricing through Monte Carlo simulations on trees we are implic- itly using risk neutral probabilities, this is also so when computing the spot rate duration. Is this correct? Shouldn't measures of sensitivity be computed with risk natural probabilities?

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Definitions:

Beta

An indicator of how much a stock fluctuates in comparison to the general market, with a beta greater than 1 signifying that the stock has higher volatility than the market.

Risk-Free Rate

The theoretical rate of return of an investment with zero risk, often represented by the yield on government securities.

Expected Return

The projected average return on an investment, accounting for all potential outcomes and their probabilities.

Expected Market Return

The average return anticipated from an investment in a broad market index over a certain period.