ABSTRACT
R isk neutral absence of arbitrage pricing is a widely used approach to derivative pricing that, when understood properly, can be extremely powerful. In this
chapter, I will explain the basic idea of risk neutral pricing. This introduction does not follow the standard probability-heavy route, but instead motivates risk neutral pricing in a direct manner from the factor approach. I hope you appreciate the simplicity with which we arrive at the concept of risk neutral pricing, and the idea that it can be seen as a natural and logical consequence of the factor approach. In fact, it arises out of a simple question that perhaps may have entered your mind as you worked through this book...
