What are 'RiskNeutral Probabilities'
Riskneutral probabilities are probabilities of future outcomes adjusted for risk, which are then used to compute expected asset values. The benefit of this riskneutral pricing approach is that the once the riskneutral probabilities are calculated, they can be used to price every asset based on its expected payoff. These theoretical riskneutral probabilities differ from actual real world probabilities; if the latter were used, expected values of each security would need to be adjusted for its individual risk profile.
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BREAKING DOWN 'RiskNeutral Probabilities'
A key assumption in computing riskneutral probabilities is the absence of arbitrage. The concept of riskneutral probabilities is widely used in pricing derivatives.
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