Explanation:
The correct answer is A.
The drift that varies with time is called a time-dependent drift. Just as with constant drift, time-dependent drift over each time period represents some combination of the risk premium and the expected changes in the short-term rate.
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Q.1656 Model 1 and model 2 are usually known as equilibrium term structure models because of the zero or constant drifts respectively. On the other hand, the model which varies with time is known as the time-dependent drift. In this model, the drift depends on time and may vary from date to date. From your understanding, what does the time-dependent drift represent over a period of time?
A
It represents some combination of the risk premium and some expected changes in the short-term rate.
B
It represents some changes in the market short-term rates over time.
C
It represents expected changes in the volatility of short-term rates and market returns over time.
D
It only represents changes in the risk premium occurring over a period of time.
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