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The risk neutral measure is often said to reflect the risk aversion of investors. So intuitively, I would think that an asset's expected discounted value should be lower under the risk neutral measure (-> market price) than under the real world measure. In other words, a risk averse investor should always prefer a fixed payout equal to the expected discounted value (under the real world measure) to holding the risky asset.

However, in a simple Black/Scholes model with constant volatility, I would expect the expected discounted value of a put option to be higher under the risk neutral measure than under the real world measure. This is because the stock, when modelled under the risk neutral measure, would take more negative paths, giving the put option a greater value.

Is this correct? And how does that fit together with the intuition about investors being risk averse, if we imagine an investor who only wants to buy one put option and has no other assets in this portfolio?

Interested in your thoughts, thanks :)

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Your first paragraph is a bit confusing. The real world measure is the one that takes into account risk aversion (hence higher discount rates and lower price). The risk neutral measure is equivalent to assuming no risk aversion and therefore produces in general higher prices for assets. What I have just said is true for long positions in assets that are positively correlated with the overall market portfolio (thus, you only get paid for taking non diversifiable risk).

Now you may ask, what if an investor has a short position in a stock (such as implicitly is that case if you are long a put option). That is a risky position so you should get paid for that. But it is actually not the case because overall, the market is long that asset and it is priced according to investors' overall position.

I detect in your question some possible confusion about how options are priced versus how assets in general are priced. Remember, assets such as stocks are priced according to how risky they are, in a real world measure. Options and other derivatives are priced using risk neutral discounting, using the price of the stock as an input.
Hope that clears up a few things.

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  • $\begingroup$ I'm not sure I agree that my interpretation re risk aversion and risk neutral measures is really that wrong. See e.g. also the second paragraph here investopedia.com/terms/r/…. I think what you are saying about correlation to the overall market and risks being diversifiable could hint at an answer to my question potentially. I understand how options are priced thats why I suspect that under risk neutral measure the expected payout of a put option is higher. $\endgroup$
    – Kolti
    Apr 5 at 17:38
  • $\begingroup$ Hi @Kolti I looked at that reference and I find it to be completely misleading. Perhaps others can weigh in. $\endgroup$
    – dm63
    Apr 6 at 18:58

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