Explanation:
In risk-neutral pricing, the original interest rate process is modified by adjusting the probabilities associated with different future interest rate movements. The modified process, known as the risk-neutral measure, is chosen such that the expected discounted value of the contingent claim under the risk-neutral measure is equal to its market price. This modification is done only once based on the assumption of no arbitrage opportunities.
By using the risk-neutral measure, the contingent claim can be priced without the need to construct and price its replicating portfolio. This makes the pricing process more efficient as it
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Q.1628 Risk-neutral pricing is a technique that modifies an assumed interest rate process so that any contingent claim can be priced without having to construct and price its replicating portfolio. It is an extremely efficient way to price many contingent claims under the same assumed rate process because:
A
the original interest rate process has to be modified once or more than once, and this modification only requires pricing the contingent claim(s) by arbitrage.
B
the original interest rate process has to be modified only once, and this modification only requires pricing the contingent claim(s) by arbitrage.
C
the original interest rate process does not need to be modified, and there is no need to price the contingent claim(s) by arbitrage.
D
None of the above.
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