Ross Recovery and the Contemporaneous Pricing Kernel

34 Pages Posted: 10 Aug 2021

See all articles by Marie-Hélène Gagnon

Marie-Hélène Gagnon

Université Laval - Faculté d'Administration

Gabriel Power

Université Laval - Département de Finance et Assurance

Dominique Toupin

Bishop’s University - Williams School of Business

Date Written: June 24, 2021

Abstract

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

Gagnon, Marie-Hélène and Power, Gabriel and Toupin, Dominique, Ross Recovery and the Contemporaneous Pricing Kernel (June 24, 2021). Available at SSRN: https://ssrn.com/abstract=3873322 or http://dx.doi.org/10.2139/ssrn.3873322

Marie-Hélène Gagnon (Contact Author)

Université Laval - Faculté d'Administration ( email )

Quebec G1K 7P4
Canada

Gabriel Power

Université Laval - Département de Finance et Assurance ( email )

Pavillon Palasis-Prince
Quebec G1K 7P4
Canada

Dominique Toupin

Bishop’s University - Williams School of Business ( email )

Canada

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