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Generalized Recovery

63 Pages Posted: 8 Dec 2015 Last revised: 26 Jun 2017

Christian Skov Jensen

Copenhagen Business School - Department of Finance

David Lando

Copenhagen Business School - Department of Finance

Lasse Heje Pedersen

AQR Capital Management, LLC; Copenhagen Business School - Department of Finance; New York University (NYU); Centre for Economic Policy Research (CEPR)

Date Written: June 26, 2017

Abstract

We characterize when physical probabilities, marginal utilities, and the discount rate can be recovered from observed state prices for several future time periods. We make no assumptions of the probability distribution, thus generalizing the time-homogeneous stationary model of Ross (2015). Recovery is feasible when the number of maturities with observable prices is higher than the number of states of the economy (or the number of parameters characterizing the pricing kernel). When recovery is feasible, our model is easy to implement, allowing a closed-form linearized solution. We implement our model empirically, testing the predictive power of the recovered expected return and other recovered statistics.

Keywords: asset pricing theory, financial economics, pricing kernel, risk aversion

JEL Classification: G00, G1, G12, G13, G17

Suggested Citation

Jensen, Christian Skov and Lando, David and Pedersen, Lasse Heje, Generalized Recovery (June 26, 2017). Available at SSRN: https://ssrn.com/abstract=2674541

Christian Jensen (Contact Author)

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

David Lando

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark
+45 3815 3600 (Fax)

Lasse Pedersen

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

New York University (NYU) ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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