F567.s2020.exercise 10.solution.pdf - Finance 567 Financial...

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Finance 567 Spring 2020 Financial Risk Management Neil D. Pearson Name: Solution to In-Class Exercise 10 Wednesday, February 19, 2020 (4 points) 1. A stock price S 1 follows the process ln S 1,0 = ln(100), ln S 1, t = ln S 1, t 1 + µ 1 + ε where ε 1, t ~ N(0, σ 1 2 ) is independent of ε 1, u for u t . The price of a second stock S 2 follows the process ln S 2,0 = ln(100), ln S 2, t = ln S 2, t 1 + µ 2 + ε where ε 2, t ~ N(0, σ 2 2 ) is independent of ε 2, u for u t and the correlation between ε 1, t and ε corr( ε 1, t , ε 2, t ) = ρ (a) (2 points) What is the variance of the random variable y t = ε 2, t ε 1, 1, t , 2, t , 2, t = . t ?
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