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A risk-neutral measure is a probability measure that yields an expected present value (discounted at the risk-free rate) which is equal to the current market price. The risk-neutral measure is also called an equivalent martingale measure.

1 vote

Does MPR imply strategies with positive average return?

Yes, the existence of non-zero market price of risk implies the existence of strategies with a positive expected return. The expected return is the compensation demanded for bearing market risk. The …
  • 5,688
3 votes
Accepted

Why does DCF discount at WACC and not risk-free rate?

A dollar to be received with certainty (for example, you have purchased a bill from the US government) at time $t$ will be valued at $e^{-rt}$. If you are uncertain about whether you will receive the …
  • 5,688
7 votes
Accepted

Drift rate vs. Riskless rate in the Black-Scholes model

Let's take your questions in turn - If volatility isn't a concern, an investor is concerned with $$ E[\log S_T] = \log S_0 + (\mu - \tfrac{1}{2}\sigma^2)T $$ when deciding to purchase a stock, …
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11 votes
Accepted

Would it be possible to combine long butterfly with long straddle, achieving profit no matte...

Your butterfly is short a straddle and long a strangle. If you add a long straddle with the same strike/notional you are now just long a strangle. The payoff for a strangle is zero if the terminal pri …
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