The Recovery Theorem
We can only estimate the distribution of stock returns, but from option prices we observe the distribution of state prices. State prices are the product of risk aversion—the pricing kernel—and the natural probability distribution. The Recovery Theorem enables us to separate these to determine the ma...
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| Other Authors: | |
| Format: | Article |
| Language: | en_US |
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American Finance Association/Wiley
2015
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| Online Access: | http://hdl.handle.net/1721.1/99126 https://orcid.org/0000-0001-8894-5217 |
| _version_ | 1811081712065576960 |
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| author | Ross, Stephen A. |
| author2 | Sloan School of Management |
| author_facet | Sloan School of Management Ross, Stephen A. |
| author_sort | Ross, Stephen A. |
| collection | MIT |
| description | We can only estimate the distribution of stock returns, but from option prices we observe the distribution of state prices. State prices are the product of risk aversion—the pricing kernel—and the natural probability distribution. The Recovery Theorem enables us to separate these to determine the market's forecast of returns and risk aversion from state prices alone. Among other things, this allows us to recover the pricing kernel, market risk premium, and probability of a catastrophe and to construct model-free tests of the efficient market hypothesis. |
| first_indexed | 2024-09-23T11:51:16Z |
| format | Article |
| id | mit-1721.1/99126 |
| institution | Massachusetts Institute of Technology |
| language | en_US |
| last_indexed | 2024-09-23T11:51:16Z |
| publishDate | 2015 |
| publisher | American Finance Association/Wiley |
| record_format | dspace |
| spelling | mit-1721.1/991262022-10-01T06:26:46Z The Recovery Theorem Ross, Stephen A. Sloan School of Management Ross, Stephen A. We can only estimate the distribution of stock returns, but from option prices we observe the distribution of state prices. State prices are the product of risk aversion—the pricing kernel—and the natural probability distribution. The Recovery Theorem enables us to separate these to determine the market's forecast of returns and risk aversion from state prices alone. Among other things, this allows us to recover the pricing kernel, market risk premium, and probability of a catastrophe and to construct model-free tests of the efficient market hypothesis. 2015-10-02T12:25:43Z 2015-10-02T12:25:43Z 2015-03 Article http://purl.org/eprint/type/JournalArticle 00221082 1540-6261 http://hdl.handle.net/1721.1/99126 Ross, Steve. “The Recovery Theorem.” The Journal of Finance 70, no. 2 (April 2015): 615–48. https://orcid.org/0000-0001-8894-5217 en_US http://dx.doi.org/10.1111/jofi.12092 The Journal of Finance Creative Commons Attribution-Noncommercial-Share Alike http://creativecommons.org/licenses/by-nc-sa/4.0/ application/pdf American Finance Association/Wiley SSRN |
| spellingShingle | Ross, Stephen A. The Recovery Theorem |
| title | The Recovery Theorem |
| title_full | The Recovery Theorem |
| title_fullStr | The Recovery Theorem |
| title_full_unstemmed | The Recovery Theorem |
| title_short | The Recovery Theorem |
| title_sort | recovery theorem |
| url | http://hdl.handle.net/1721.1/99126 https://orcid.org/0000-0001-8894-5217 |
| work_keys_str_mv | AT rossstephena therecoverytheorem AT rossstephena recoverytheorem |