medium · FRM Part 1 Valuation and Risk Models
The risk-neutral valuation principle is often described as a 'pricing device.' This implies that:
- The probabilities used in the model are the best forecasts of future events.
- It can only be used to price derivatives, not to manage their risk.
- We do not actually need to believe the world is risk-neutral to use the model.
- The model only works if investors are truly indifferent to risk.
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