Abstract
Risk-neutral pricing of European call options is investigated from a mathematical point-of-view and is found to be a specious concept1. Risk-neutral pricing of European call options is an approximation in which all terms of order are ignored, where is the risk premium and σ is the volatility.
Highlights
Open AccessThe concept of risk-neutral pricing of European call options is investigated from a mathematical approach
Risk-neutral pricing of European call options is an approximation in which all terms of order (α − r ) σ are ignored, where α − r is the risk premium and σ is the volatility
It is found that risk-neutral pricing used in the pricing of European call options is a specious concept [1] [2] [3] that is only approximately correct and that ignores terms of (α − r ) σ, where α − r is the risk premium and σ2 is the variance of the one-day return of the asset that underlies the call option
Summary
The concept of risk-neutral pricing of European call options is investigated from a mathematical approach. It is found that risk-neutral pricing used in the pricing of European call options is a specious concept [1] [2] [3] that is only approximately correct and that ignores terms of (α − r ) σ , where α − r is the risk premium and σ2 is the variance of the one-day return of the asset that underlies the call option. The risk premium equals (α − r ) with α the true drift rate of the underlying option and r the risk-free rate
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