A Simple Derivation of Risk-Neutral Probability in the Binomial Option Pricing Model
International Journal of Mathematical Education in Science and Technology, Vol. 46, No. 1, 2015.
6 Pages Posted: 25 Apr 2014 Last revised: 25 Aug 2019
Date Written: April 24, 2014
The traditional derivation of risk-neutral probability in the binomial option pricing framework used in introductory mathematical finance courses is straightforward, but employs several different concepts and is is not algebraically simple. In order to overcome this drawback of the standard approach, we provide an alternative derivation.
Keywords: derivative, arbitrage, arbitrage-free pricing, risk-neutral, risk-neutral probability
JEL Classification: A20, A22, A23, G12, G13
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