Risk Neutral

DEFINITION of 'Risk Neutral'

Indifference to risk. The risk-neutral investor would be in the middle of the continuum represented by risk-seeking investors at one end, and risk-averse investors at the other extreme. Risk-neutral measures find extensive application in the pricing of derivatives.

BREAKING DOWN 'Risk Neutral'

A risk-neutral investor is more concerned about the expected return on his or her investment, not on the risk he or she may be taking on. A classic experiment to distinguish between risk-taking appetites involves an investor faced with a choice between receiving, say, either $100 with 100% certainty, or a 50% chance of getting $200.


The risk-neutral investor in this case would have no preference either way, since the expected value of $100 is the same for both outcomes. In contrast, the risk-averse investor would generally settle for the "sure thing" or 100% certain $100, while the risk-seeking investor will opt for the 50% chance of getting $200.

RELATED TERMS
  1. Equivalent Martingale Measures

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

    A theoretical measure of probability derived from the assumption ...
  3. Risk Seeking

    The search for greater volatility and uncertainty in investments ...
  4. Conversion Arbitrage

    An options trading strategy employed to exploit the inefficiencies ...
  5. Investment

    An asset or item that is purchased with the hope that it will ...
  6. Risk

    The chance that an investment's actual return will be different ...
Related Articles
  1. Options & Futures

    A Beginner's Guide To Hedging

    Learn how investors use strategies to reduce the impact of negative events on investments.
  2. Investing Basics

    Calculating Risk and Reward

    Investing money into the investment markets has a high degree of risk, and if you're going to take the risk, the amount of money you stand to gain needs to be big.
  3. Investing Basics

    Determining Risk And The Risk Pyramid

    Many investors do not understand how to determine the risk level their individual portfolios should bear.
  4. Investing

    Measure Your Portfolio's Performance

    Learn three ratios that will help you evaluate your investment returns.
  5. Bonds & Fixed Income

    Find The Highest Returns With The Sharpe Ratio

    Learn how to follow the efficient frontier to increase your chances of successful investing.
  6. Active Trading

    How Companies Use Derivatives To Hedge Risk

    Derivatives can reduce the risks associated with changes in foreign exchange rates, interest rates and commodity prices.
  7. Options & Futures

    5 "New" Rules For Safe Investing

    Did the credit crisis leave a new landscape for investors? Maybe, but it's not as unfamiliar as you may have imagined.
  8. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  9. Investing

    3 Healthy Financial Habits for 2016

    ”Winning” investors don't just set it and forget it. They consistently take steps to adapt their investment plan in the face of changing markets.
  10. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
RELATED FAQS
  1. What is finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Full Answer >>
  2. What is the difference between positive and normative economics?

    Positive economics is objective and fact based, while normative economics is subjective and value based. Positive economic ... Read Full Answer >>
  3. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  4. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  5. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  6. Why are mutual funds subject to market risk?

    Like all securities, mutual funds are subject to market, or systematic, risk. This is because there is no way to predict ... Read Full Answer >>
Hot Definitions
  1. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  2. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  3. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  4. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  5. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center