EXERCISE 5.1 The term premium at time t for the future period [t′, T] is the current forward rate for that period minus the expected spot rate, i.e. ft′,T t − Et[yT t′ ]. This exercise will give a link between the term premium and a state-price deflator = (t).

(a) Show that

for any t t′ T.

(b) Using the above result, show that

Using the previous result and the approximation ex 1 + x, show that

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