Excess return per unit of risk

Explain the concept of the market price of risk.

It is the extra expected return investors demand per unit of a source of risk: for a stock, $\lambda=(\mu-r)/\sigma$. In a no-arbitrage model all assets driven by the same risk must share the same $\lambda$. For traded assets it disappears from option prices via hedging, but for untradable variables (interest rates, volatility) it appears in the pricing equation and must be specified or calibrated.