AppliedMultiple choice
Why is the risk-neutral probability used in option pricing generally different from the real-world probability of an up move?
- ABecause investors are assumed to be risk-neutral in the models that use it
- BBecause it is the probability that makes discounted asset prices martingales, which absorbs the risk premium
- CBecause real-world probabilities cannot exist for continuous price processes
- DBecause the risk-neutral probability is always exactly one half in a recombining tree
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