Short-rate joint-measure models

John Hull, Alexander Sokol and Alan White introduce a new concept, called local price of risk, to construct and calibrate a joint-measure model describing the evolution of interest rates under both the real-world and risk-neutral measures. This can be used for a variety of risk management applications

Traditionally, derivatives researchers have tended to focus on the (risk-neutral) Q-measure because of its role in pricing. Since the crisis, risk management has assumed an increasing importance and there is now a realisation among many researchers that the (real-world) P-measure should be given more attention. In this paper we propose a way to construct a single forward-looking model for interest rates, which represents their evolution under both the Q-measure and P-measure (a joint-measure