Problem bank
Problem 331 of 333MediumStochastic CalculusP331
How long to tell a good stock from a flat one?
Two analysts watch the same stock, which follows a GBM with volatility . Analyst A says its drift is . Analyst B says the drift is . You observe the whole price path continuously on .
(a) Use Girsanov to write the likelihood ratio in terms of the path. Which part of the path does it depend on?
(b) Suppose A is right. What is the probability that the likelihood ratio favours A after 10 years? How many years of data do you need for that probability to reach 95%?
(c) Analyst C agrees with B about the drift but says . Why does one day of continuous data settle the argument between B and C?
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