Risk-Neutral Measures


DEFINITION of 'Risk-Neutral Measures'

A theoretical measure of probability derived from the assumption that the current value of financial assets is equal to their expected payoffs in the future discounted at the risk-free rate. Another assumption made is that there is an absence of arbitrage. The term derives its name from the fact that all financial assets have the same expected rate of return - i.e., the risk-free rate.

Also known as equivalent martingale measure or Q-measure.

BREAKING DOWN 'Risk-Neutral Measures'

The concept of a risk-neutral measure is used to price derivatives. The risk-free rate of return is the return on an investment where the theoretical risk is zero. In practice, the interest rate on three-month U.S. Treasury bills is commonly used as a proxy for the risk-free rate.

  1. Equivalent Martingale Measures

    In asset pricing, a probability distribution of expected payouts ...
  2. Risk-Neutral Probabilities

    Probabilities of future outcomes adjusted for risk, which are ...
  3. Risk Tolerance

    The degree of variability in investment returns that an individual ...
  4. Risk-Adjusted Return

    A concept that refines an investment's return by measuring how ...
  5. Risk Neutral

    Indifference to risk. The risk-neutral investor would be in the ...
  6. Risk Averse

    A description of an investor who, when faced with two investments ...
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