Functional Ross Recovery: Theoretical Results and Empirical Tests

58 Pages Posted: 27 Jun 2017 Last revised: 14 Nov 2020

See all articles by Yannick Dillschneider

Yannick Dillschneider

University of Amsterdam - Amsterdam School of Economics (ASE)

Raimond Maurer

Goethe University Frankfurt - Finance Department

Date Written: September 13, 2019

Abstract

Recently, Ross (2015) showed that the real-world probability distribution of a discrete Markovian state variable can be recovered from observed option prices. The so-called recovery theorem follows from Perron-Frobenius matrix theory when the pricing kernel is transition independent. In this paper, we generalize the recovery theorem to continuous state spaces using Perron-Frobenius operator theory. Building on our theoretical results, we devise a nonparametric estimation approach to empirically recover the pricing kernel and real-world probability density in closed form. Using S&P 500 index options, we analyze recovered pricing kernels empirically and find evidence that Ross recovery is misspecified.

Keywords: Ross recovery, pricing kernel, state price density, Perron-Frobenius theory

JEL Classification: G00, G10, G12, G13

Suggested Citation

Dillschneider, Yannick and Maurer, Raimond, Functional Ross Recovery: Theoretical Results and Empirical Tests (September 13, 2019). Journal of Economic Dynamics and Control, Volume 108, November 2019, 103750, Available at SSRN: https://ssrn.com/abstract=2991984 or http://dx.doi.org/10.2139/ssrn.2991984

Yannick Dillschneider (Contact Author)

University of Amsterdam - Amsterdam School of Economics (ASE) ( email )

Roetersstraat 11
Amsterdam, North Holland 1018 WB
Netherlands

Raimond Maurer

Goethe University Frankfurt - Finance Department ( email )

Gr├╝neburgplatz 1
House of Finance
Frankfurt, 60323
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
398
Abstract Views
1,782
rank
101,982
PlumX Metrics