Risk Neutral

Reviewed by Sujaini | Updated on Oct 05, 2020

What is Risk Neutral?

Risk neutral is used both in the study of game theory and in finance. It refers to a mentality in which a person is indifferent to risk when deciding to invest. This mentality is derived not from calculation or rational deduction but an emotional preference.

An individual with a risk-neutral approach doesn't concentrate on the risk, regardless of whether or not it's a foolish thing to do. This way of thinking is always situational and can rely on price or other external factors.

Understanding Risk Neutral

Risk neutral is a concept used to describe an individual's mindset, who may be analysing alternative investments. If the person focuses solely on potential benefits irrespective of the risk, they are considered to be a neutral risk.

Such behaviour may seem inherently risky to evaluate reward without a thought for risk. A risk-averse investor wouldn't consider risking Rs 1,000 loss with the possibility of making Rs 50 gain being the same risk as a risk-taking choice of only Rs 100 to make the same Rs 50 gain.

However, someone who is dangerous will be optimistic. Because of two investment opportunities, the risk-neutral investor looks only at each investment's potential benefits and ignores the potential downside risk.

Risk Neutral Pricing and Measures

There can be several causes why an individual would achieve a risk-neutral mentality. Still, the idea that an individual could change from a risk-averse attitude to a risk-neutral mindset based on price changes leads to another vital concept: risk-neutral measures.

Risk-neutral measures have extensive application in derivatives pricing because the price at which investors would be expected to display a risk-neutral attitude should be a price of balance between buyers and sellers.

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