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.

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