Part 9 - Risk Neutral Prob Flashcards
1
Q
Risk-neutral probabilities meaning
A
Risk-neutral probabilities overweight bad states and underweight good states relative to a physical distribution, reducing the payoff in expectation.
1
Q
Will the expected value of a risky asset be higher or lower under a risk-neutral distribution than under the physical distribution?
A
It will be lower under the risk-neutral distribution. Under the q measure the return is the risk-free rate. Under the physical, the return will be higher, because the probability of good outcomes is understated in the q measure.
