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Does the Ross recovery theorem work empirically?

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2020

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Journal of Financial Economics. Elsevier. 2020, 137(3), pp. 723-739. ISSN 0304-405X. eISSN 1879-2774. Available under: doi: 10.1016/j.jfineco.2020.03.006

Zusammenfassung

Starting with the fundamental relation that state prices are the product of physical probabilities and the stochastic discount factor, Ross (2015) shows that, given strong assumptions, knowing state prices suffices to back out physical probabilities and the stochastic discount factor at the same time. We find that such recovered physical distributions based on the S&P 500 index are incompatible with future returns and fail to predict future returns and realized variances. These negative results are even stronger when we add economically reasonable constraints. Simple benchmark methods based on a power utility agent or the historical return distribution cannot be rejected.

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Fachgebiet (DDC)
330 Wirtschaft

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Ross recovery; Stochastic discount factor; Risk-neutral density; Transition state prices; Physical probabilities

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ISO 690JACKWERTH, Jens, Marco MENNER, 2020. Does the Ross recovery theorem work empirically?. In: Journal of Financial Economics. Elsevier. 2020, 137(3), pp. 723-739. ISSN 0304-405X. eISSN 1879-2774. Available under: doi: 10.1016/j.jfineco.2020.03.006
BibTex
@article{Jackwerth2020-09recov-50639,
  year={2020},
  doi={10.1016/j.jfineco.2020.03.006},
  title={Does the Ross recovery theorem work empirically?},
  number={3},
  volume={137},
  issn={0304-405X},
  journal={Journal of Financial Economics},
  pages={723--739},
  author={Jackwerth, Jens and Menner, Marco}
}
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