State Prices and Implementation of the Recovery Theorem

Alex Backwell
Additional contact information
Alex Backwell: Department of Actuarial Science and the African Collaboration for Quantitative Finance and Risk Research, University of Cape Town, Rondebosch, Cape Town 7700, South Africa

JRFM, 2015, vol. 8, issue 1, 1-15

Abstract: It is generally held that derivative prices do not contain useful predictive information, that is, information relating to the distribution of future financial variables under the real-world measure. This is because the market’s implicit forecast of the future becomes entangled with market risk preferences during derivative price formation. A result derived by Ross [1], however, recovers the real-world distribution of an equity index, requiring only current prices and mild restrictions on risk preferences. In addition to being of great interest to the theorist, the potential practical value of the result is considerable. This paper addresses implementation of the Ross Recovery Theorem. The theorem is formalised, extended, proved and discussed. Obstacles to application are identified and a workable implementation methodology is developed.

Keywords: Recovery Theorem; Ross recovery; real-world measure; predictive information; state prices; state-price matrix (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://www.mdpi.com/1911-8074/8/1/2/pdf (application/pdf)
https://www.mdpi.com/1911-8074/8/1/2/ (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:gam:jjrfmx:v:8:y:2015:i:1:p:2-16:d:44897

Access Statistics for this article

JRFM is currently edited by Ms. Chelthy Cheng

More articles in JRFM from MDPI
Bibliographic data for series maintained by MDPI Indexing Manager ().