Risk-Neutral Probabilities Explained

27 Pages Posted: 27 Apr 2009 Last revised: 20 Oct 2010

Nicolas Gisiger

affiliation not provided to SSRN

Date Written: October 10, 2010

Abstract

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.

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

Suggested Citation

Gisiger, Nicolas, Risk-Neutral Probabilities Explained (October 10, 2010). Available at SSRN: https://ssrn.com/abstract=1395390 or http://dx.doi.org/10.2139/ssrn.1395390

Nicolas Gisiger (Contact Author)

affiliation not provided to SSRN ( email )

Paper statistics

Downloads
12,765
Rank
190
Abstract Views
30,209