Risk Neutral Pricing

Risk-neutral pricing is a method used in finance to determine the value of an asset or option by assuming investors are indifferent to risk. Instead of considering how risky the investment actually is, we imagine a scenario where all investors expect the same return regardless of risk. This simplifies calculations because, under this assumption, the asset’s price is based on its expected future payoff discounted at a risk-free rate. Essentially, it’s a mathematical tool that helps accurately and efficiently price complex financial derivatives by removing individual risk preferences from the calculation.