A Recovery that We Can Trust? Deducing and Testing the Restrictions of the Recovery Theorem

47 Pages Posted: 20 Nov 2016 Last revised: 13 Sep 2017

See all articles by Gurdip Bakshi

Gurdip Bakshi

Fox School of Business

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management

Xiaohui Gao Bakshi

Fox School of Business, Temple University

Date Written: July 23, 2017

Abstract

How reliable is the recovery theorem of Ross (2015)? We explore this question in the context of options on the 30-year Treasury bond futures, allowing us to deduce restrictions that link the physical and risk-neutral return distributions. Our empirical results undermine the implications of the recovery theorem. First, we reject an implicit assumption of the recovery theorem that the martingale component of the stochastic discount factor is identical to unity. Second, we consider the restrictions between the physical and risk-neutral return moments when the recovery theorem holds, and reject them in both forecasting regressions and generalized method of moment estimations.

Keywords: recovery theorem

JEL Classification: G10, G11, G12

Suggested Citation

Bakshi, Gurdip S. and Chabi-Yo, Fousseni and Gao, Xiaohui, A Recovery that We Can Trust? Deducing and Testing the Restrictions of the Recovery Theorem (July 23, 2017). Forthcoming, Review of Financial Studies. Available at SSRN: https://ssrn.com/abstract=2872909 or http://dx.doi.org/10.2139/ssrn.2872909

Gurdip S. Bakshi (Contact Author)

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone)
tuk40718@temple.edu (Fax)

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

Xiaohui Gao

Fox School of Business, Temple University ( email )

Philadelphia, PA 19122
United States

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