Question

Which of the following statements about risk-neutral pricing is most accurate?

Select one:

While most investors are risk averse, it doesn’t matter if we assume that investors are risk neutral for the purpose of pricing derivatives.

The risk-neutral approach was state of the art until Black-Scholes developed their Nobel-prize-winning formula.

Some investors are risk-averse, some are risk-neutral and some are risk-seeking. Market prices represent a consensus of various investors’ opinions. As such, prices reflect an averaging of various investors’ opinions, giving a state of risk-neutrality.

The risk-neutral approach is valid for the types of derivatives that attract risk-neutral traders. For derivatives that attract risk-averse traders, a more-traditional valuation approach must be adopted.

Answer 1

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