Linked Questions

49 votes
8 answers

How does the "risk-neutral pricing framework" work?

I've struggled for a long time to understand this - What is this? And how does it affect you? Yes I mean risk neutral pricing - Wilmott Forums was not clear about that.
Jack Kada's user avatar
  • 809
39 votes
5 answers

Why aren't econometric models used more in Quant Finance?

There is a big body of literature on econometric models like ARIMA, ARIMAX or VAR. Yet to the best of my knowledge practically nobody is making use of that in Quantitative Finance. Yes, there is a ...
vonjd's user avatar
  • 27.2k
19 votes
6 answers

Risk Neutral Probability

I read that an option prices is the expected value of the payout under the risk neutral probability. Intuitively why is the expectation taken with respect to risk neutral as opposed to the actual ...
Mykie's user avatar
  • 325
21 votes
5 answers

Why quants think that the risk-neutral measure should not be used for financial forecasting?

In posts regarding the $\mathbb{P}$ vs $\mathbb{Q}$ debate (see 1, 2, 3 or 4), most answers conclude that historical-based forecast are better suited than risk-neutral models for financial predictions....
sets's user avatar
  • 1,431
18 votes
2 answers

Bayes' rule for conditional expectations (Proof review)

The Baye's rule for conditional expectations states $$ E^Q[X|\mathcal{F}]E^P[f|\mathcal{F}]=E^P[Xf|\mathcal{F}] $$ With $f=dQ/dP$ - thus being the Radon-Nikodyn derivative and $X$ being ...
Probilitator's user avatar
  • 3,357
19 votes
1 answer

$\mathbb{P}$ vs $\mathbb{Q}$ Probabilities - Transitioning Between Measures

I'd like this question to definitively guide a practitioner to using both $\mathbb{P}$ vs $\mathbb{Q}$ probabilities in trading and research. Let's take only one fact as given: if I have a risk-...
Jared's user avatar
  • 695
13 votes
1 answer

What is the difference between risk neutral probabilities and stochastic discount factor?

My question is regarding the difference between risk neutral probabilities and stochastic discount factor? I am confused as to how are they related?
Andy's user avatar
  • 423
10 votes
1 answer

Arbitragefree Pricing: Q vs. P

I read that the Fundamental Theorem of Asset Pricing states, that a market is arbitrage-free if and only if there exists an equivalent martingale measure Q, under which the discounted asset price ...
emcor's user avatar
  • 5,719
7 votes
2 answers

Interpret simulation results ($P$ and $Q$ measures)

I am struggling in interpreting results of my simulations. I use Monte Carlo algorithm to simulate stock paths and calculate option price. The notation: $r$ is a risk free interest rate, $T$ is time ...
tosik's user avatar
  • 456
5 votes
1 answer

How to price this basket option?

Underlying assets are three global stock index : Eurostoxx 50, HSI, KOSPI 200 Maturity: 36 months with advanced redemption date in every 6 months if prices of indexes satisfy given conditions at each ...
smw1991's user avatar
  • 93
4 votes
1 answer

Data Selection for Empirical Pricing Kernel Estimation (Stochastic Discount Factor)

I want to estimate an empirical pricing kernel for an index. Hence, I need to estimate a physical and risk neutral density. For estimating the physical density, only the index data in an observed time ...
Finance_Newbie's user avatar
1 vote
1 answer

How to infer real world measure from risk neutral measure

Assume we have inferred risk neutral density of stock price at time T from option prices. Assume we have obtained a parameterized density p(S). How can we infer real world measure? I know about ...
braaterAfrikaaner's user avatar
2 votes
1 answer

Relationship between risk-neutral probability and subjective probability

I recently came across a Paper by a paper of Rubinstein and Jackwerth (1997): where they assume that you ...
Alkibiades's user avatar
2 votes
1 answer

Real world probabilities from option implied risk neutral density?

The work of Breeden and Litzenberger-formula ( gives us a risk neutral probability distribution of a stock price, depending on the option ...
Lejoon's user avatar
  • 147
1 vote
1 answer

construct volatility smile based on historic observations

So I calculated historic volatility/skewness/kurtosis for a commodity. I now would like to construct a volatility smile that reflects this historically realized distribution. I tried using some ...
bramvs's user avatar
  • 23

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