Ross recovery with time series information and economic constraints

52 Pages Posted: 22 Mar 2019 Last revised: 12 Sep 2022

See all articles by Paul Schneider

Paul Schneider

University of Lugano - Institute of Finance; Swiss Finance Institute

Date Written: March 22, 2019

Abstract

I propose a new type of Ross recovery informed from time series, and subject to shape restrictions from economic theory. Within my data-driven and nonparametric framework, I find that decreasing marginal utility, or a monotonic stochastic discount factor, strongly dominates the more flexible pure no-arbitrage model out-of-sample. Both specifications, with or without monotonicity imposed, imply an equity premium the cyclicality of which changes conditionally with the state of the world. Both generate sizable out-of-sample predictability of realized returns beyond extant conditional predictors and recovery frameworks.

Keywords: Ross recovery, monotonic SDF, options, dimension reduction, factor model, scenario analysis, machine learning.

JEL Classification: G11, G12, G15

Suggested Citation

Schneider, Paul Georg, Ross recovery with time series information and economic constraints (March 22, 2019). Swiss Finance Institute Research Paper No. 19-17, Available at SSRN: https://ssrn.com/abstract=3358388 or http://dx.doi.org/10.2139/ssrn.3358388

Paul Georg Schneider (Contact Author)

University of Lugano - Institute of Finance ( email )

Via Buffi 13
CH-6900 Lugano
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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