Risk-neutral measures

A risk-neutral measure is a mathematical tool used in finance to evaluate the expected value of future payoffs, such as investments or derivatives, assuming investors are indifferent to risk. It adjusts probabilities so that all assets grow at the risk-free rate, simplifying complex market realities. This approach allows practitioners to price derivatives accurately without needing to predict individual risk preferences, making calculations more manageable. Essentially, it provides a consistent framework to determine fair values of financial instruments by focusing on a hypothetical world where investors don’t require extra compensation for taking on risk.