PROCESS A: "Driftless" geometric Brownian motion (GBM). "Driftless" means no "dt" term. So it's our familiar process: ds = o S dw with S(O) = 1. o is the volatility. PROCESS B: ds = a S2 dw for some constant a, with S(0) = 1 As we've said in class, for any process the instantaneous return is the random variable: dS/S = (S(t + dt) - S(t)/S(t) = [1] Explain why, for PROCESS A, the variance of this instantaneous return (VAR[ds/S]) is constant (per unit time). Hint: What's the variance of dw? The rest of this problem involves PROCESS B. [2] For PROCESS B, the statement in [1] is not true. Explain why PROCESS B's variance of the instantaneous return (per unit time) depends on the value s(t).
