I am currently a second year university student studying business, so excuse my lack of knowledge regarding the subject.
I am currently studying the binomial options pricing model, which involves working out the risk neutral probabilities involving states: up/down. A risk neutral-measure implies that there is no arbitrage in the market.
The formula for this would be:
Sd * P + Su * (1-P) = S * (1 + Rf)
If we were pricing an equity call option, for example, why wouldn't we use the return on equity derived from the capital asset pricing model for that particular stock, instead of using the risk free rate?
I partly understand that the principle of no arbitrage breaks down, but what assumptions may be broken if we use CAPM instead of Rf?