Many financial models price their assets with an underlying assumption of risk aversion baked into the mathematics. In fact, the volatility shock component of Geometric Brownian Motion effectively proves this to be true. However, Option Pricing Models, such as Black-Scholes, more often assume risk neutrality in their pricing.
Why is there a discrepancy between these two states, and when is one needed over the other? In today’s Skinny, we address those questions.
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