Functional Ross recovery: Theoretical results and empirical tests

Yannick Dillschneider and Raimond Maurer

Journal of Economic Dynamics and Control, 2019, vol. 108, issue C

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 approach to empirically estimate the recovered pricing kernel and 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 (search for similar items in EconPapers)
JEL-codes: G00 G10 G12 G13 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:108:y:2019:i:c:s0165188919301496

DOI: 10.1016/j.jedc.2019.103750

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