Ross Recovery and the Contemporaneous Pricing Kernel
34 Pages Posted: 10 Aug 2021
Date Written: June 24, 2021
This chapter investigates the contemporaneous pricing kernel obtained by applying the recovery theorem to options on the S&P500 index. Similarly to the literature on the pricing kernel puzzle, I find evidence that the recovered pricing kernels are U-shape, but only some of the time. The different shapes observed for the recovered kernels appear to be clustered in time, indicating that they are a genuine feature of risk preferences and not just an artifact created by noisy pricing kernel estimates. Although the recovered contemporaneous kernels cannot significantly predict future realized returns over the whole distribution, they are successful for the first 3 quartiles. A practitioner needing an instantaneous measure of downside risk could therefore obtain such information by applying the recovery theorem to options data.
Keywords: pricing kernel; Ross recovery; risk-neutral; options
JEL Classification: G13; P34
Suggested Citation: Suggested Citation