Talk:Risk neutral
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Can someone answer me this question:
You are offered a lottery with the following prizes: £100, £50, or £10. The probabilities of each prize are respectively: 0.1, 0.2, or 0.7.
What sum of money would a risk neutral individual pay for this lottery ticket?
.1*100 + .2*50 + .7*10 = 10+10+7 = 27 Wolfman 22:57, 21 Nov 2004 (UTC)
Regarding pricing, keep this in mind: risk-neutral pricing only really makes sense for pricing options. The 'break-through' of the Black-Scholes option pricing model is that it's risk-neutral, meaning that the investor's tolerance for risk is not a part of the formula. Generally, if you're pricing cash flows in the future, you need some sort of discount rate, which is the rate of return that an investor demands to receive that cash flow in the future rather than in the present. If the cash flow is seen as uncertain (risky), the investor will demand a higher discount rate, meaning that the investor is assigning a lower present value to that future cash flow. A risk-seeking individual will accept lower discount rates than a risk-averse person. This makes it very hard to establish the correct discount rate. So again, the cool thing about B-S option pricing is that it doesn't require an expected rate of return at all. If you're pricing an option on a stock, the expected return on that stock is NOT relevant to B-S pricing. That's what this risk-neutral business is all about. Tristanreid (talk) 15:56, 11 June 2008 (UTC)
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BetacommandBot 11:34, 6 July 2007 (UTC)
