Risk-neutral probability
Principles of Finance glossary · Risk, Return & Portfolio Theory
Definition
A probability adjusted so that expected returns equal the risk-free rate; the basis of arbitrage-free derivative pricing.
Risk-neutral probability in plain English
A risk-neutral probability is a clever accounting trick, not a real-world odds estimate. Instead of asking 'how likely is this really?', you deliberately tweak the probabilities so that every investment appears to earn exactly the safe rate — as if nobody cared about risk at all. This sounds strange, but it makes pricing complicated bets (like options) much cleaner, because in a world with no free money to be grabbed, that adjusted-probability math gives one fair price everyone must agree on. It's a pricing shortcut: change the weights so the risk washes out, then the fair value pops out.
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