The Recovery Theorem

59 Pages Posted: 11 Jan 2013

See all articles by Stephen A. Ross

Stephen A. Ross

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Yale University - International Center for Finance

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Date Written: January 11, 2013


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 so as to determine the market’s forecast of returns and the market’s risk aversion from state prices alone. Among other things, this allows us to recover the pricing kernel, the market risk premium, the probability of a catastrophe, and to construct model free tests of the efficient market hypothesis.

Keywords: asset pricing theory, financial economics

JEL Classification: G00, G1, G12

Suggested Citation

Ross, Stephen A., The Recovery Theorem (January 11, 2013). Journal of Finance, Forthcoming, Available at SSRN:

Stephen A. Ross (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Yale University - International Center for Finance

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