risk-neutral valuation

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A method for valuing financial assets. Risk-neutral valuation calculates the value of an asset by discounting the expected value of its future pay-offs at the risk-free rate of return. The expected value is not obtained using the actual probabilities of each pay-off. Instead, risk-neutral valuation calculates the expected value of future pay-offs using constructed probabilities that have the property of rationalizing observed asset prices if all investors were risk-neutral.

Subjects: Economics.

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