Arbitrage-based recovery

Ferenc Horvath

Journal of Financial Economics, 2025, vol. 163, issue C

Abstract: We develop a novel recovery theorem based on no-arbitrage principles. To implement our Arbitrage-Based Recovery Theorem empirically, one needs to observe the Arrow–Debreu prices only for one single maturity. We perform several different density tests and mean prediction tests using more than 26 years of S&P 500 options data, and we find evidence that our method can correctly recover the probability distribution of the S&P 500 index return on a monthly horizon, despite the presence of a non-trivial permanent SDF component.

Keywords: Recovery theorem; Physical probabilities; Stochastic discount factor; No-arbitrage (search for similar items in EconPapers)
JEL-codes: G1 G12 G13 G17 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:163:y:2025:i:c:s0304405x24001922

DOI: 10.1016/j.jfineco.2024.103969

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