Which of the following statements is false?
A) In both the Binomial and Black-Scholes Pricing Models, we need to know the risk-neutral probability of each possible future stock price to calculate the option price.
B) In the real world, investors are risk averse. Thus, the expected return of a typical stock includes a positive risk premium to compensate investors for risk.
C) Because no assumption on the risk preferences of investors is necessary to calculate the option price using either the Binomial Model or the Black-Scholes formula, the models must work for any set of preferences, including risk-neutral investors.
D) If all market participants were risk-neutral, then all financial assets (including options) would have the same cost of capital - the risk-free rate of interest.

Question

Quizplus · Accepted Answer

In the Black-Scholes Pricing Model, the risk-neutral probability is not directly calculated or needed to determine the option price. Instead, the model uses the risk-free rate, volatility of the underlying asset, and other factors to calculate the price. The concept of risk-neutral probabilities is more explicitly used in the Binomial Model.

Which of the Following Statements Is False