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woundedtiger4
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Are both same or different? Can someone give me some example to understand?
Thanks in advance
Thanks in advance
Probability is a measure of the likelihood of an event occurring, expressed as a number between 0 and 1. Risk neutral probability, on the other hand, is a theoretical concept used in financial modeling to represent the probability of future outcomes under the assumption that investors are risk neutral.
Probability is calculated by dividing the number of desired outcomes by the total number of possible outcomes. For example, if you roll a six-sided die, the probability of rolling a 3 would be 1/6 (1 desired outcome out of 6 possible outcomes).
No, probability cannot be greater than 1. A probability of 1 means that the event is certain to occur, while a probability of 0 means that the event will not occur. Any number between 0 and 1 represents the likelihood of the event occurring.
Risk neutral probability is used in finance to calculate the present value of future cash flows. It assumes that investors are indifferent to risk, so the expected return on an investment is the same as the risk-free rate. This allows for easier comparison and evaluation of different investment options.
One limitation of using risk neutral probability is that it does not reflect the actual levels of risk aversion among investors. It also assumes that markets are efficient and do not have any frictions, which may not always be the case in reality. Additionally, it does not account for unforeseen events or changes in market conditions that may impact the actual probabilities of future outcomes.