Risk-Neutral Probabilities Explained
affiliation not provided to SSRN
October 10, 2010
All too often, the concept of risk-neutral probabilities in mathematical finance is poorly explained, and misleading statements are made. The aim of this paper is to provide an intuitive understanding of risk-neutral probabilities, and to explain in an easily accessible manner how they can be used for arbitrage-free asset pricing. The paper is meant as a stepping-stone to further reading for the beginning graduate student in finance.
Number of Pages in PDF File: 27
Keywords: derivative, redundant asset, arbitrage, arbitrage-free pricing, risk-neutral, risk-neutral probability, martingale, martingale measure, Girsanov, geometric Brownian motion, Gisiger, Nicolas Gisiger
JEL Classification: A20, A22, A23, G12, G13
Date posted: April 27, 2009 ; Last revised: October 20, 2010