What is the risk-neutral measure?

Just like Aaron Brown’s argument in Red Blooded Risk.

Fermat's Last Spreadsheet

Here is a short list of the most common ‘big-concept’ questions that I was asked throughout my years as a quant (whether coming from people on the trading floor, in control functions, or from newcomers to the team), in no particular order:

What is the risk-neutral measure?

What is arbitrage-free pricing?

What is a change of numeraire?

What is the ‘market price of risk’?

I don’t know of a single book on financial mathematics that attempts to give answers to these questions for a reader that is not familiar with stochastic calculus (which most traders are not, of course). Over a series of posts I will put down my own user-friendly answers to these questions, and we’ll end up with a grand Guide to Financial Derivatives Pricing for a Non-Technical User!

This post covers the first: what is the risk-neutral measure?

View original post 1,256 more words

About isomorphismes

Argonaut: someone engaged in a dangerous but potentially rewarding adventure.
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