An Empirical Analysis of the Ross Recovery Theorem
39 Pages Posted: 6 May 2014 Last revised: 1 Mar 2015
Date Written: February 28, 2015
Building on the method of Ludwig (2015) to construct robust state price density surfaces from snapshots of option prices, we develop a nonparametric estimation strategy for the recovery theorem of Ross (2013). Using options on the S&P 500, we then investigate whether or not recovery yields predictive information beyond what can be gleaned from risk-neutral densities. Over the 13 year period from 2000 to 2012, we find that market timing strategies based on recovered moments significantly outperform those based on their risk-neutral counterparts.
Keywords: risk-neutral density, pricing kernel, risk aversion, predictive information
JEL Classification: C14, C58, G13
Suggested Citation: Suggested Citation